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Trade Deficit Weighs on U.S. Economy

The trade deficit, which is seen increasing to $39 billion in February, restricts the U.S. economic recovery.

The U.S. trade deficit for February will grab investors' attention Tuesday when the Commerce Department releases its report on the monthly balance of imports and exports.

On average, analysts expect the trade deficit to increase to $39.0 billion from $37.3 billion in January. My forecast is in line with that consensus.

The trade deficit, along with the credit and housing bubbles, was a principal cause of the Great Recession. Now, a rising trade deficit and continued weakness among regional banks threatens to stifle the emerging recovery and keep unemployment near 10% through 2011.

At 3.1% percent of GDP, the trade deficit subtracts more from the demand for U.S.-made goods and services than President Obama's stimulus package adds. Moreover, Obama's stimulus is temporary, whereas the trade deficit is permanent and growing again.

Subsidized manufactures from China and petroleum account for nearly the entire U.S. trade deficit, and both will rise as consumer spending and oil prices increase through 2010.

Money spent on Chinese coffeemakers and Middle East oil cannot be spent on U.S.-made goods and services, unless it is offset by exports.

When imports substantially exceed exports, Americans must consume much more than they earn producing goods and services, or the demand for what they make will be inadequate to clear the shelves, inventories will pile up, layoffs will result, and the economy will go into recession.

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To keep Chinese products artificially inexpensive on U.S. store shelves and discourage U.S. exports into the Middle Kingdom, China undervalues its currency, the yuan, by 40%.

Beijing accomplishes this by printing yuan and selling them 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 28% percent of its exports of goods and services.

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

Longer term, China's currency policies reduce U.S. growth by one percentage point a year. The U.S. economy would likely be $1 trillion larger today if not for the trade deficits with China over the last 10 years.

In negotiations with U.S. Treasury Secretary Timothy Geithner, China has suggested a 3% revaluation of its currency over the next year, but such a small change would do little to change the current situation. In fact, because of Chinese modernization, the intrinsic value of China's currency rises each year. Hence, a 3% revaluation over the next year would not even amount to the change in yuan undervaluation.

As the U.S. trade balance with China grew worse, Beijing could say, "See, exchange rates don't matter."

President Obama must weigh much tougher action against Chinese mercantilism, or China's trade policies will impose slow growth and high unemployment on the U.S.

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.