The U.S. monetary and fiscal policies are spent forces. They can no longer be used as active growth drivers in discretionary demand management actions.
The Federal Reserve has done all it could to rescue the economy and the financial system in the aftermath of its unforgivable policy mistakes that led to the Great Recession. Conscious of the fact that the deep wounds are still healing, the Fed is now trying to prudently unwind its long-held crisis credit stance.
In the first 11 months of this year, the Fed has withdrawn $374.6 billion of its high-powered money at a modest monthly rate of $34.1 billion. But that still left at the end of November a huge monetary base (M0) of $3.5 trillion — a nearly five-fold increase from pre-crisis levels in 2007.
The interbank market is also bubbling with $1.6 trillion worth of excess reserves, the money banks can readily loan out to creditworthy private sector customers — in addition to mopping up some of Uncle Sam’s extravagant IOU offerings.
Of course, in case of need, the Fed, as a lender of last resort, can always relapse into mindless quantitative easing routines — but that would again be a desperate measure of a seemingly never-ending crisis management. Markets, however, would be unlikely to greet with enthusiasm such a repeat performance.
The fiscal policy lever is even more impaired. That is quite obvious from a gross public debt of $22 trillion (107 percent of GDP), and counting, and a public sector budget deficit currently estimated at about 6 percent of GDP.
The latest data, released last Thursday, are pointing to a worsening trend of public finances. In the course of November, federal spending shot up 18 percent from the year earlier while revenues fell 1 percent — in spite of relatively strong economic activity. For the first two months of the present fiscal year, the federal budget deficit soared 51 percent from the same period of 2017, and was running at a mind-boggling annual rate of $1.8 trillion.
How, under those circumstances, can anybody expect that the financial markets could digest such a huge public sector borrowing requirement without causing considerable damage to asset prices?
There are no easy solutions to that predicament, but a rapidly improving U.S. trade balance could go a long way toward preventing a major economic slowdown and providing some support to stretched market valuations.
Here are a few numbers to show where the U.S. stands on that now.
This year, the deficit on American foreign trade in goods and services is expected to take out of the economy more than $550 billion, or 2.7 percent of GDP.
Goods trade alone is considerably worse. In the first 10 months of this year, the U.S. ran a $623 billion trade deficit with China, Europe and Japan. That amount represents 84 percent of the total gap on American international goods transactions.
A substantial reduction of that deficit through increasing U.S. exports, and import substitution via incoming direct investments in local production, would provide considerable support to American economic growth.
Trade with China is the most prominent example of such a possibility. Systematic deficits on China trades is America’s increasingly important — and seriously worsening — decades-old problem. Last year’s deficit of $347 billion accounted for 46 percent of the total U.S. trade gap. This year, that deficit was matched in the first 10 months, and represented 55.3 percent of the total.
But the most appalling statistic is this: Last year, U.S. exports to China soared at an annual rate of 12.8 percent; in the first 10 months of this year, they were down 1 percent.
Trade deficits with China are excessive and intolerable. Their continuing increase is the most unexpected development in view of President Donald Trump’s thorough acquaintance with that problem since the early days of his presidential campaign in 2015. It is, therefore, most regrettable — and damaging to the U.S. economy — that, after his two years in office, America is taking such a thrashing from China on its vitally important economic issues.
I would have never thought that, at this point in Trump’s presidency, we would still be in the early stages of an unnecessarily difficult trade negotiation, rejoicing at the crumbs of China’s soybean purchases and promised tariff leniency on U.S.-made automobile imports — in exchange for Washington’s good behavior.
Kudos to China. A country that now causes more than half of U.S. trade deficits, takes nearly half-a-trillion dollars of American wealth and technology, violates the rules of international trade adjustment and operates with generally condemned trade rules and practices is setting the agenda and the pace of trade negotiations with the Trump administration.
It is also incredible to see that nothing is being done to reduce American trade deficits with Europe and Japan — a total of $221.9 billion in the first 10 months of this year. One would have thought that it should be much easier, and faster, to balance those trade accounts because, unlike in the case of China, Washington would be dealing with friends and allies in Brussels, Berlin and Tokyo.
Given their record over the last two years, Washington strategists seem to know nothing about the trade multiplier — the extent to which an improving trade balance increases business investments, profits, employment creation, household incomes, personal consumption and residential investments.
Regrettably, expect no relief to America’s sharply worsening trade position. The deficit on goods and services is estimated to soar next year to nearly $700 billion.
Meanwhile, the Fed will be holding the fort. Stabilizing core consumer and producer prices around 2 percent and 2.5 percent, respectively, unit labor costs at 1.4 percent in the first three quarters of this year and a 3.7 percent increase of the dollar index over the last three months signal no pressing need for imminent rate hikes.
Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.
