Trade deficits, tariffs and farming - where are we at?

Wanted to ramble a bit on tariffs and trade issues, since that's still looming as a major wild card for the coming months in the US economy.

We had an update on the US trade deficit just last week. So let’s go inside that release from the Bureau of Economic Analysis and see what it said.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis announced today that the goods and services deficit was $57.6 billion in February, up $0.9 billion from $56.7 billion in January, revised.

February exports were $204.4 billion, $3.5 billion more than January exports. February imports were $262.0 billion, $4.4 billion more than January imports.

The February increase in the goods and services deficit reflected an increase in the goods deficit of $0.3 billion to $77.0 billion and a decrease in the services surplus of $0.6 billion to $19.4 billion.

Year-to-date, the goods and services deficit increased $21.1 billion, or 22.7 percent, from the same period in 2017. Exports increased $22.4 billion or 5.9 percent. Imports increased $43.6 billion or 9.1 percent.

Not great numbers, with the $57.6 billion trade deficit for February is $13 billion more than it was just 6 months prior to that, and the largest deficit since the Great Recession.



The flip side is that both imports ($23.7 billion) and exports ($10.7 billion) have gone up for the US over those 6 months, and some might argue that reflects a strong economy on both the consumer side and on the Us exporter side.

The goods deficit in china has stayed on the high side, and was at an estimated $34.7 billion for February, and $70.2 billion for 2018 so far, an increase of 19% vs the first 2 months of 2017. Almost all of that increase reflects an increase in US imports of $11 billion, while exports of goods to China have remained mostly steady (a little over $21 billion for Jan-Feb 2017 and 2018).

UW’s Menzie Chinn has forgotten more about trade issues than I’ll ever care to know, and he brings up two intriguing possibilities on the effects that any US vs China trade war may have on Chinese consumers and American farmer (since agricultural products are the main ones that would be tariffed by China).

Chinn says a big question is how much American soybeans (as an example) are needed by Chinese consumers. In addition, given that products that have some parts made in other countries and go through China on the way to the US will be an especially hard hit on China.

For instance, a 25% tariff on US soybeans, could result in a 25% increase in prices of imported soybeans in China. Or it could result in 0% if the US is a very small supplier in global markets. Well, the US is pretty large (largest single exporter), so let’s say 15% of the tariff is reflected in Chinese prices. The other 10% is reflected in US prices, both domestic and foreign (as long as there is no other segmentation imposed). I wonder at the equanimity of those contemplate from the safety of afar what 10% price reduction means….

While the dollar amount trade covered by retaliation proposed by the Chinese is roughly the same as that of the US under Section 301 (around $50 billion), the tariffs of 25% is on gross value. This matters, since it’s likely for most of the imports from the US to China, the US value added is close to 100%. On the other hand, as noted in this post, roughly 50% of the value of US imports from China is foreign sourced. Taken literally, a 25% tariff on gross value works out to 50% tariff on Chinese value added. Of course, it might be that the Chinese value added in the imports covered by the Section 301 tariffs is a higher proportion than 50% (phones were excluded, for instance). Still, the nominal 25% tariff is likely to translate into a higher tariff rate on Chinese value added. So the pain inflicted on Chinese exporters targeted is higher than that on American exporters, ceteris paribus.

Prof. Chinn says another option might be for the Chinese not to put tariffs on American products, but to make the American products more expensive (and their products less expensive in the US) by dropping the value of their currency.

The preceding analysis abstracts from exchange rates. However, China has (still) a partially managed exchange rate. The threat that China would unload its Treasurys I always thought an empty one; the capital losses would be too large (of course stopping purchases would be an option that might not be as obviously costly; some recent estimates of impacts on Treasury yields here).

However, China could do the opposite, and buy more Treasurys, strengthening the dollar, i.e., weakening the yuan. There is substantial scope for depreciation, as shown in Figure 2.



…So, in order to restore competitiveness, all China needs to do is to engineer a depreciation/rebuild forex reserves. (Because the Fed does not have a bilateral trade balance mandate, I don’t think the US would respond, via interest rates, in kind.) A managed CNY depreciation would run afoul of charges of currency manipulation by trading partners, and perhaps put China on Treasury’s watchlist for manipulators. But then, you have to wonder: what more sanctions we could place on China for currency manipulation?

I also found this story from the week interesting, particularly in light of the possibility of tariffs being placed on certain US agricultural products by China and others.

U.S. corn exports jumped to the highest in at least 23 years [in the first week of April] amid adverse crop weather in the Americas and the threat of Chinese trade tariffs.

A persistent drought in Argentina has cut grain output, and dry weather into May may curb production of the second-season harvest in Brazil. Cold, wet weather in the next two weeks will crimp U.S. planting, increasing risks that Midwest crops will pollinate during hot weather in July, further reducing prospects for global supplies.

U.S. exports in the week ended April 5 jumped 60 percent to 1.94 million tons from a year earlier to the highest since the Department of Agriculture began reporting the data in 1995. Japan and Mexico were the biggest buyers with a small amount sold to China, which is embroiled in a trade dispute with the Trump administration.

So watch for the higher prices there when you’re at the store in the near future. I guess that’s one small bright side for farmers this year in a time when lower prices in many other areas are killing off large amounts of smaller farms.

Wall Street keeps ping-ponging back and forth depending on how seriously they take Trump's tough talk on trade, and on how severe (or not severe) any tariffs and other restrictions may be. But the bigger story may be what's happening now, as the trade deficit keeps rising along with our fiscal deficit, and the effect of that on the dollar, consumer prices and interest rates may affect the economy a lot more than any particular tariffs or other trade barriers will.