Trade Gap Punishes GDP

The higher trade deficit threatens to derail the recovery and dramatically increase unemployment later in 2010.
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The Commerce Department reported the deficit on international trade in goods and services was $49.9 billion in June, much higher than the $42.5 billion expected by analysts. This jump in the deficit will slash estimates of second-quarter GDP growth, and threatens to derail the recovery and dramatically increase unemployment later in 2010.

Second-quarter GDP growth will likely be downgraded from 2.4% to something closer to 2%.

Dollars that go abroad to purchase U.S. imports cannot be spent on U.S. goods and services. When those dollars do not return to purchase U.S. exports, jobs are lost and not replaced. A rising trade deficit slows growth and increases unemployment.

But for the increase in the trade gap, GDP would have grown 5.2%, and unemployment would fall to 7.5 by early 2011, and less than 5% by 2013.

Oil and consumer goods from China account for nearly the entire trade deficit, and sustained economic recovery is not possible without dramatic changes in energy and trade.

President Obama's efforts to halt offshore drilling and otherwise curtail conventional energy supplies -- premised on false assumptions about the immediate potential of electric cars and alternative energy sources -- threaten to make the United States even more dependent on imported oil.

Detroit can build many more attractive and efficient gasoline-powered vehicles now, and a national policy to accelerate the replacement of the existing fleet would reduce imports, spur growth and create jobs.

To keep Chinese products artificially inexpensive on U.S. store shelves and discourage U.S. exports into China, Beijing undervalues the yuan by 40%. It accomplishes this by printing yuan and selling those for dollars to augment the private supply of yuan and private demand for dollars. In 2009, those purchases were about $450 billion or 10% of China's GDP, and about 35% of its exports of goods and services.

In 2010, the trade deficit with China reduces U.S. GDP by more than $400 billion or nearly 3%. Unemployment would be falling and the U.S. economy recovering more rapidly, but for the trade imbalance with China and Beijing's protectionist policies.

In June, China indicated it will adopt a more flexible exchange rate policy, but it has made clear Americans should not expect a dramatic change in the value of the yuan.

China recognizes President Obama is not likely to counter Chinese mercantilism with strong, effective actions; hence, it offers token gestures and cultivates political support among U.S. businesses like General Motors profiting from investments in China.

President Obama should impose a tax on dollar-yuan conversions in an amount equal to China's currency market intervention divided by its exports -- in 2009 that was about 35%. For imports, at least, that would offset Chinese subsidies that harm U.S. businesses and workers.

Until the President tackles the root causes of the trade deficit, unemployment will remain near 10% and could surge much higher.

Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.