Friday, October 16, 2009

The Truth About Trade Deficits.

The dreaded "trade deficit" is shrinking...let's celebrate! Wait a minute, this is happening in the context of the worst unemployment in a quarter of a century, a jump in inflation, and a period of protracted economic decline.

The balance of trade -- the amount of goods imported versus goods exported -- has been a tool used by those who are shallow in their economic knowledge and deep in their fear of competition. We are told by many politicians that trade deficits (importing more than we export) is a "terrible" thing and demonstrates an economy in decline. As a result of decades of trade deficits, the US is a "debtor" nation, we are told.

So the recent news stories should be good news: "Trade Gap Continues to Narrow." This narrowing is because the amount of goods we are importing each year is actually shrinking. There are few, if any, who would argue that this economy is anything but weak and has been in a downward spiral. This reality should not be a surprise to any student of history. When the economy is weak, we can't afford to buy. Our trade deficit shrinks with our spending power.

In 1928 Republican Herbert Hoover was running for President of the United States against Democrat Al Smith of New York. Hoover, the Secretary of Commerce under one of the most successful Presidents in US history, was running against a very popular governor. It was easy for Hoover to defend the record of the President he served, Calvin Coolidge, as virtually every indicator pointed to an administration noted for its prosperity. "A chicken in every pot and a car in every garage" was a message that rang true to most voters.

During the 20s, Coolidge and his allies took a tax rate that was as high as 70 percent under their predecessor and lowered the top rate to a low of 5 percent. Coolidge opened economic trade with countries and unleashed a level of prosperity we had not seen in generations. The number of people who made six digits (a very high income in the 1920s) increased four fold. Inflation was less than 2 percent and unemployment was at a comparable amount. They called it the "Roaring Twenties" for a reason.

In spite all the glitter, there were signs of "rust" for those who cannot look beyond the surface. That was the trade deficit that grew rapidly during his administration. This area fell under the Secretary of Commerce and Hoover was taunted by his opponent through out the race as the man who over saw this area of "decline." Finally Hoover got on the protectionist bandwagon and told voters that if Smith or he were elected, there would be quotas and tariffs placed on trade. Hoover won and by the Fall of 1929, he was sticking to his guns and pursuing protectionism in the form of the Smoot-Hawley Tariff Act.

That law did exactly what it intended to do -- slash the import of goods. Within a few years, the US had its first trade surplus in decades and also one of the highest unemployment rates in history. The Stock Market crash that proceeded the Depression was fueled by this trade protectionism. Wall Street knew that, if we penalized imports, foreign countries would retaliate. That led to the Market crash because investors knew that the value of goods would decline as the trade markets would shrink.

The high unemployment rate was associated with the trade surplus for a very simple reason. We imported more goods than we exported because our buying power had declined dramatically. Through out our nation's history over the last century, our periods of highest prosperity were accompanied by eras of trade deficits. Meanwhile, trade surpluses accompanied economic decline. In our prosperity we were buying more, from everywhere.

Today, the trade deficit is shrinking because the economy is weak. Our national buying power is in decline. Trade deficits continue to do what they have done for centuries -- indicate strength and not weakness.

Kevin Price is Host of the Price of Business, the longest running show on AM 650 (M-F at 11 am) in Houston, Texas and on AOL Radio. His articles often appear in Chicago Sun Times, Reuters, USA Today, and other national media. Steve Moore of the Wall Street Journal calls Price the “best business talk show host in the country.” Find out why and visit his blog at www.BizPlusBlog.com and his show site at www.PriceofBusiness.com. You can also find Price on Strategy Room at FoxNews.com.

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