1 May 2007

Why trade deficit matters

By Hans D. Baumann

The U.S. trade deficit could affect the future of your jobs, the location of our plants, and it might even cause the next recession.

Our current trade deficit with China has reached $21 billion per month. It means we bought $21 billion more in one month from China than the value of goods we sold them.

This makes the trade deficit with China alone about $250 billion on a yearly basis. Adding the trade deficits with Europe and Japan, among others, we had a record total trade deficit of $856 billion in 2006, about $70 billion per month.

Who pays for it?

The U.S. government does, by issuing IOUs, which is to say government bonds. At 5% interest rate, we, the taxpayers, have to pay every year $150 billion in interest to mostly foreign bondholders.

The continuous increase in foreign debt may force the Federal Reserve Bank to keep increasing interest rates in order to entice foreign borrowers to buy bonds in order to finance the deficit.

The real danger in this is higher interest rates could cause a U.S. recession and added unemployment because it becomes more expensive for industry to borrow money for future plant expansions.

The question: "What caused this huge trade deficit?" After all, this has only started to mushroom during the last 10 years. The reason lies in the onset of "globalization."

In plain English, it is the transfer of industrial labor from the U.S. to foreign countries. To make us understand what this implies, there are only three areas of wealth creation in a given country:

  1. Agriculture: This was number one prior to the onset of the industrial revolution.
  2. Mining:  This includes oil and gas production.
  3. Industry: This last category provided the largest contribution to our exports and created the high standard of living we have all enjoyed since the 1940s.

Exports of agricultural products have steadily decreased, and since 2004, we now import more food items than we export. The same is true for oil. We enjoyed energy independence prior to the late 1970s, and we now import 2/3rd of our needs.

This leaves only industrial products to create wealth both for exports as well as for domestic consumption. Sadly, our industry is in a poor state.

While industrial employment in the heydays of the 1960s amounted to 26% of the total workforce, we are down now to less than 8%, having lost over 4 million factory jobs since the year 2000 alone.

This trend is still going on; we are still loosing typically 14,000 industrial jobs per month. Look at it another way-now our factories produce only 12.7% of our gross national product.

In contrast, service jobs create 66%. With the exception of some banking, licensing, and minor activities, service jobs do not produce national wealth; neither do they create much foreign currency earnings.

What can we do about this? Reversing this trend is very difficult, and any adjustments we have to make will negatively affect our standard of living. This means prices will increase at Wal-Mart and at the gas pump.

There are only two ways out of this difficulty:

  1. Drastically decrease the value of the U.S. dollar. This will make our products much more competitive and as a result will increase our exports, that is, there will be more sales of U.S. made products to foreign countries.
  2. Wait for the future when there will be an increase in the wages of foreign workers especially in China and India, leading to a price increase of their goods, leading to us importing less. Either way, importing less (because foreign goods are more expensive) or exporting more (because our goods are cheaper), the trade imbalance will lessen and or go away.

Most importantly, this will revive our industry and create more domestic jobs.

About the Author

Dr. Hans D. Baumann, P.E. is 'Mr. Valve' having designed over 30 valve lines, holding 154 patents, writing hundreds of papers and seven books on the subject, and being in possession of an endless litany of awards and citations. He has industrial engineering education and a Ph.D. in mechanical engineering. He is an ISA member and a member of Sigma Xi.