Trade deficit big problem for U.S. economy, expert says

Northwestern Financial Review, Feb 15-Feb 28, 2005 by Bengtson, Tom

Additional increases in interest rates by the Federal Reserve are not likely to contribute to inflation, but they will make it more difficult for the United States to service its debt. Concerns over the nation's trade deficit have supplanted inflation worries as the dark cloud on the country's economic horizon, according to Scott Brown. The chief economist for Raymond James and Associates addressed a group of 120 bankers participating in a joint meeting of Financial Women International and the Risk Management Association. The Jan. 19 meeting took place in the IDS center in downtown Minneapolis.

Noting that the Fed lowered Fed Funds rates 13 times on the way to 1 percent before it began raising rates last year, Brown said he expects rates to climb to around 4 percent from its current level at 2.25 percent. "The debate is really over how fast the Fed is going to raise rates over the next several months," he said.

Brown noted that long-term interest rates are low, and actually declined near the end of 2004. "This is very unusual," he said. "You have the Fed raising short-term rates and long-term rates don't seem to be affected." Noting that the Federal government has gone from a budget surplus of $300 billion to a deficit of $500 billion, Brown said the government is borrowing a lot more money. Typically, greater deficit spending leads to higher long-term interest rates. Brown explained that's not happening because the government is borrowing most of its money "on the short end of the yield curve."

This debt management strategy saves money in the short run, but Brown called it a risky strategy because the nation's debt servicing expense will increase as short-term rates increase. "It may have made more sense to lock in long-term interest rates," he said.

Brown said the country's trade deficit, or account deficit as it is sometimes called, was 5.6 percent of GDP in the third quarter and is expected to be around 6 percent for the fourth quarter. "In November, we had a trade deficit of $60.3 billion," he said. "That's $2 billion per day going overseas."

Brown clarified: "What the current account deficit is, is the mirror image of these capital flows into the United States. And what these capital inflows are is an increase in U.S. external debt. The debt - what the U.S. owes the rest of the world - is the cumulative effect of these current account deficits. We have to fund the current account deficit by borrowing more and more. The external debt is now rising at a pretty substantial rate. It is probably going to end the year at about 25 percent of GDP."

The size of the debt is not the problem, Brown told the audience. "It's the debt service burden. As the Fed continues to raise short-term interest rates, the cost of servicing the debt rises," Brown aid. "Even if we start to improve the current account balance this external debt is still going to be rising."

Brown said part of the long-term solution is greater savings by Americans. He said economic growth in other countries will help the United States, if it means they increase their purchases of U.S. goods and services. And the United States could slow its purchase of foreign goods and services, he suggested.

Brown delivered a positive assessment of the economy, outside its difficulties with the trade deficit. "Household fundamentals are pretty good," he said, with purchases of durable goods holding steady and coming back somewhat.

Job growth, which averaged 186,000 jobs per month in 2004, was good, he said. The rate of job growth in the late 1990s, when the economy was adding 300,000 jobs per month, was unsustainable, he said. About 145,000 jobs need to be added to the economy each month to keep up with the growth in the working age population, he said.

Oil prices pose a modest threat to the economy, but he said high energy prices will only slow the rate of economic growth, not retard it. He said people today spend a smaller portion of their money on energy than they did in the 1970s, when the price of oil wreaked havoc with the economy.

Brown said housing prices are high across the country and some economists are worried the bubble will burst. He said he thinks there will be a "correction," but that its affect will be largely limited to the homes that have seen the greatest price increases. He also said the housing market is worldwide, and inflated home prices are not unique to the United States. "A housing collapse would be a world issue," he said.

Brown is a member of the Economic Advisory Council of the American Bankers Association. Prior to joining Raymond James in 1993, Brown was a manager of economic research at Pacific First Bank in Seattle.

By Tom Bengtson