January 26, 2010
Economy at a Glance
U.S. foreign trade position becomes more familiar; Canada’s remains an anomaly
ALEX CARRICK
Chief Economist, CanaData
In November 2009, the U.S. foreign trade deficit in goods and services was on the rise again, which was a return to a more typical position, while in Canada, the merchandise trade position shifted back into deficit, which was not normal at all in a historical sense.
The U.S. deficit has reached -$437 billion USD after bottoming out at -$310 billion USD in May. The U.S. goods alone deficit is now -$581 billion, which is partially offset by a $144-billion surplus in services.
The drop in value of the greenback versus many of the world’s other major currencies will act to slow, but not halt, the increase in the U.S. trade deficit. There is too much dependence on foreign cheap consumer goods and oil. The latter has recovered half of its peak-to-trough decline in price and now stands above $80 USD per barrel. This does not augur well for the U.S. trade deficit.
The trade numbers hold wide-ranging implications. The rising U.S. trade deficit will be in addition to Washington’s fiscal budgetary deficit of $1.4 trillion in 2009 and an expected $1.0 trillion in 2010. These put downward pressure on the value of the U.S. dollar. This is not helped by the Federal Reserve’s plan to hold interest rates next to zero through the first half of this year.
Other countries are stepping in to help prop up the U.S. dollar. The logic is straightforward. China pegs the value of its currency to the greenback. As the U.S. dollar falls, so does the value of the yuan. This hurts the export-competitive positions of firms in India, South Korea, Singapore, Indonesia and elsewhere. Their governments’ response has been to buy U.S. dollars.
China’s position on a fixed exchange rate with the U.S. seems unsustainable. Chinese authorities are already taking action to curb excessive growth in that nation. The reserve requirement for banks is being raised from 15.5% to 16.0% for large banks and from 13.5% to 14.0% for smaller banks. This will help rein in the record-high levels of lending that have been taking place.
There is concern in China about asset price bubbles developing in stock and property values. Inflation is on the rise. These factors point to interest rates in China moving higher in quick order. Once that happens, there will be more pressure on China to raise the value of the yuan.
Higher interest rates would be one more reason for “hot” money to flow into China as part of the “carry” trade. That is where money is borrowed in a country with low interest rates and invested in another with higher returns. Hot money is already an issue as money is flowing into China from outside in a flurry of speculation that the value of the yuan will be raised. The expectation is for a modest 5% gain versus the greenback in 2010. While that seems conservative, it has to be remembered that China’s very large foreign exchange holdings permit it the luxury of considerable control over its own currency value. Any appreciation will be measured and slow.
Meanwhile in Canada, a solid merchandise trade surplus is counted on to make a significant contribution to gross domestic product. In its absence, realizing positive economic growth quarter to quarter becomes harder to achieve. The increase in the world price of oil has been a help but the low level of natural gas prices has taken away those gains. As the world proceeds further along its recovery path, this will cause additional upward adjustments in resource prices.
International currency traders are betting that the outcome of higher commodity prices for Canada will be quite positive. That partly explains why the value of the loonie currently stands almost at parity with the U.S. dollar. If the loonie shoots past a one-on-one relationship with the greenback, which is a good possibility this year, then the debate over policy options will become lively and heated. At the moment, despite all statements to the contrary, Canada has little control over its interest rate policy. Rates in Canada cannot be raised ahead of those in the U.S. for fear that the value of the loonie will rise further and create even more of a problem for exporters.
For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com
the merchandise trade balance
Data source: Statistics Canada/Chart: Reed Construction Data – CanaData.
