Oil woes mask improvement in deficit

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By David M. Dickson

The soaring cost of imported oil in recent years has disguised a little-known fact: America's non-petroleum trade deficit has been plunging.

Even as the total U.S. trade deficit in goods and services has remained above $700 billion per year over the past 3 1/2 years, the non-petroleum portion of the deficit has fallen dramatically. In 2006, the trade deficit in goods other than oil was $483 billion; for the first half of 2008, projected over the whole year, it was $300 billion, or nearly 40 percent lower.

Many economists say U.S. manufacturers have begun reaping the competitive benefits of a declining dollar, which began its long, steep descent in early 2002.

"The performance of manufactured goods is so strong that it is a major offset to the rising deficit in petroleum," said Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers. "U.S. exports of manufactured goods are accelerating their torrid growth pace and are among the strongest parts of the trade picture," he said.

It isn't just increased exports of manufactured goods that have reduced the non-petroleum deficit. Farm products such as corn, wheat and soybeans have generated major surpluses in the agricultural sector as their prices have soared. Exports of chemicals and plastics have also increased markedly in recent years.

"The overall trade deficit has been declining slowly, but it is declining," said Gary Hufbauer, a senior fellow at the Peterson Institute for International Economics. "The rising price of oil has kept the deficit from falling more."

Two trends have contributed to the improvement in the trade balance despite the soaring costs for imported oil. The U.S. economic slowdown has cut Americans' demand for imported consumer goods, Mr. Hufbauer explained, while the export of manufactured goods has picked up.

"The depreciating dollar has been a big factor in the increase in exports," he said.

Measured against a weighted index of the currencies of our trading partners, the dollar depreciated 27 percent between February 2002 and July 2008. Between early 2002 and May, for example, the dollar fell 46 percent against the euro and 28 percent against the British pound.

But the greenback has rebounded in recent weeks. Since May, the dollar has gained nearly 10 percent against the euro and 7 percent against the pound.

Because the price and quantity of both imports and exports are slow to adjust to a currency's depreciation, a nation's trade balance tends to get worse before it gets better. Economists call this tendency the "J-curve effect."

America's non-petroleum trade deficit followed the early downward pattern of this J-curve, widening from $331 billion in 2002 to $483 billion in 2005 and 2006. It has also followed the curve's upward trend. After bottoming out at $483 billion, the non-petroleum trade deficit narrowed to $407 billion in 2007. During the first half of 2008, it has been running at an annual rate of $300 billion.

Of course, the overall U.S. trade deficit would have plunged too if the price of oil had not soared. As recently as 1999, America's bill for imported oil totaled less than $60 billion. Last year, it was nearly $300 billion, and during the first half of 2008, it has been running at an annual rate above $400 billion.

In early 1999, imported crude oil cost less than $10 per barrel. Last month, imported crude oil cost nearly $120 per barrel, having increased by $10.85 per barrel in June alone. Net petroleum imports have averaged 11.3 million barrels per day during the first half of this year. That's down from 12.4 million barrels a day imported in 2006, according to the Energy Information Administration.

Because oil prices, which peaked in July before falling more than 20 percent, increased much faster than U.S. petroleum imports have declined since 2006, the petroleum trade deficit has continued to soar. In June alone, the cost of imported petroleum increased to $44.5 billion from $38.8 billion in May.

Not all economists are impressed by the recent trend in the U.S. non-petroleum trade deficit.

"Now in the ninth consecutive year with U.S. economic growth slower than world growth - and in the middle of the worst financial crisis in decades - it is remarkable that the United States still cannot competitively produce and sell enough to pay for imports and must continue borrowing almost $2 billion per day in today's global financial markets," said Charles McMillion, president and chief economist of MBG Information Services in Washington.