There has been a lot of excitement generated by the sharp improvement in the trade deficit in June, leading to expectations that growth will be revised up sharply for Q2. Even more, the strength in exports has provided fuel for the manufacturing renaissance story, leading many to upgrade longer term forecasts – with consequences for when the Federal Reserve begins to remove quantitative easing. We think that is putting far too much emphasis on a single reading from a single indicator. Trade data are notoriously volatile – note that last month’s deficit was far wider than expected on a surge in energy imports, which was largely reversed this month. Moreover, the devil is often in the details. In this month’s sharp and unexpected increase in exports, re-exports of goods made outside the US accounted for roughly half of the improvement – about the same as over the past year. Bottom line, a more detailed analysis of the import and export data suggests very narrow areas of improvement and a dependence on growth in emerging markets, which is now falling into question.
Using data from the first halves of 2012 and 2013, we find the merchandise trade deficit narrowed $32 billion dollars in that time, helping generate 0.2% in headline GDP – nice, but not spectacular. All of the improvement is accounted for by a $32 billion reduction in imports of fuels as the shale oil play added one million barrels of oil to US production. (Note that one million barrels a day at $100 dollars a barrel is $36.5 billion.) Hopefully, shale oil will continue to narrow the trade gap, but as it is unlikely to accelerate from a one million a barrel a year gain, a stronger boost to GDP growth is unlikely. Meanwhile, many point to the benefits of shale gas and associated production, yet there was virtually no change in exports of chemicals or fuels between the first halves of 2012 and 2013 – they combined for only a $30 million (with an M) increase. Excluding fuel, US goods imports rose 0.9% between the first halves of 2012 and 2013, with increases widespread among industries.
Total goods exports also rose modestly during this period, up 1.0%, or $8.1 billion. A $4.3 billion increase in re-exports, which account for 13% of total US exports, represented more than half of the gain. A $2.6 billion increase in exports of jewelry and gem diamonds appears to account for the bulk of the jump in re-exports. Without re-exports, US outgoing trade rose a tepid 0.6%, or $3.8 billion. Again, more than all of the gain can be attributed to a single narrow sector, civilian aircraft (planes, engines & parts) – which saw exports rise 11.8%, or $5.4 billion. Unfortunately, even this good news is not all it seems, as imports of civilian aircraft, parts and engines also surged, by 16.6% or $2.2 billion. Thus, the total contribution to the trade deficit from aircraft was $3.2 billion, or one tenth of the 0.2% of GDP contribution from fuels. President Obama’s pledge to double US exports is facing an uphill battle in a slow growth world.
US goods exports are disbursed around the world roughly in line with global GDP shares – and like shares of world GDP the growth is all in emerging markets. The share of US exports going to Canada, Europe, Japan and the Newly Industrialized countries (South Korea, Taiwan, Singapore and Hong Kong) has declined from a peak of 66.1% in 1996 to just under half – at 48.6% — in the year ended June 2013. Interestingly, the UK reported this week that emerging market exports have now exceeded their sales to the developed world. From the first half of 2012 to the first half of 2013, exports to Japan fell 7.0% (reflecting the weakening yen), to Europe down 5.5% as they founder in recession, to the NICS up a scant 0.2%, and Canada posted a tepid 1.6% gain. Meanwhile, lower income countries saw far stronger growth, with Mexico up 4.4%, China up 4.2%, and the rest of the emerging world up 3.9%. While Japan and Europe, which account for 21% of US exports, might be expected to rebound significantly in the coming year, it is the slowing of the emerging markets, as China deals with the middle income trap, that is more worrisome.
It is not a renaissance in manufacturing, but an ongoing success in services that carries the greatest potential for the US to narrow the trade gap via exports. Service exports are roughly half the size of goods exports after eliminating re-exports. However, with a 6% gain from the first half of 2012 to the first half of 2013, they contributed a $19.4 billion boost to exports – almost five times the improvement in goods ex re-exports. Service imports rose 5%, but this smaller segment only cut $10 billion from the trade improvement. Bottom line, the US global comparative advantage is in services and in technology related goods like aircraft. The multi-national companies that dominate the US corporate culture are well aware of this and choose to expand their factory operations in emerging markets where labor is cheaper, tax advantages greater, and regulation less onerous. They export the services of skilled American labor in the form of management, royalties and fees for IPR, finance, marketing etc. Travel is one of the biggest growth areas of international trade as managers move around the world to visit their facilities. We have often argued that the US is the suburbs of the world economy – and like the suburbs its success will be in skilled service production.
Brazil’s Lack of Levers
The outlook for Brazil has been steadily downgraded over the past quarter as exposure to the emerging markets slowdown hampers exports, while domestic unrest cools the domestic economy. Expectations are now for 2.25% growth in 2013 and 3% in 2014 – looking more like the stodgy US than like a booming BRIC nation. On the verge of an international debut, with the World Cup in 2014 and the Olympics in 2016, Brazil is caught with no policy levers to pull as it seeks to satiate a young populous that has become use to steady improvements in living standards. Like many emerging markets, Brazil is facing up to structural imbalances that developed during years of strong growth. Most importantly, subsidies to the vast lower income sector – which helped spawn a vibrant consumer market – are now too heavy for the government to bear as deficits and interest cost rise with the return of inflation. President Rousseff and other politicians saw their ratings plunge in the aftermath of the winter of discontent (note, southern hemisphere) as the government tried to roll back subsidies on transportation. How are they going to handle electricity subsidies as costs spiral higher?
While elephantine finds of deep off shore oil mark Brazil’s future, the present finds them primarily dependent on hydro-electric power for electricity – and in the midst of a long drought. The shortfall in hydro-power has forced increased imports of petroleum products – in competition with the Japanese in their post-nuclear phase. Add in a sharp currency devaluation to spur exports, and energy has become quite expensive locally indeed. The result has been a surge in inflation to over 6% before cooling in the past month. Like the Germans who suffered hyper-inflation, given their history Brazilians are particularly sensitive to inflation as a measure of political stability. Higher transportation charges were an attempt to reduce petroleum demand (buses run on diesel, not ethanol) which was not well accepted. Consensus appears to be that a winter of discontent may morph into a long, hot, summer if a resolution cannot be found. While inflation may fall as the transportation charges are rolled back, rising deficits and inflation are undermining business confidence – and reinforcing corporate leaders concerns that Rousseff is no Lula.
At the heart of Brazil’s problems was an ill-timed devaluation. Like the British right after the Lehman crisis, Brazil resorted to the off tackle play when the economy slows – a 15%-plus devaluation in the currency (actually twice, in 2012 and 2013). Unfortunately, like the UK, the search for greater market share came at a time when the global pie had stopped growing. Grabbing a lion’s share of future growth is a tried and true result of devaluation – ask the Chinese in 1994. However, when the pie is static or shrinking, the current stakeholders will fight tooth and nail to keep their customers. Currency devaluations are often met with price and non-price competition. Moreover, the devaluation brought on commodity based inflation. Now, Brazil finds itself in a bind common among emerging markets. They cannot lower interest rates to stimulate growth for fear it will spark inflation before growth. They cannot reduce businesses taxes without infuriating the public and widening an already troublesome deficit. Spending subsidies to spur domestic consumption will be cheered by the masses, but spurned by corporations wary of populist measures. Sound like the catch-22 in America? The bottom line is Brazil is now waiting on someone else to spark global growth, so they can increase export sales. Not an unfamiliar, or comfortable, situation for emerging – and developed — nations in today’s global economy.