Orlando's Outlook: Trade deficit domino effect

03-20-2018

Bottom Line January’s trade deficit expanded to its widest level in a decade at $56.6 billion—28% higher than just last August. That trend hurt fourth-quarter GDP and likely also will impair this quarter’s growth. It also set into motion a domino effect, including President Trump’s decision to impose tariffs to extract better trade terms (possibly timed to sway last week’s special Congressional election in Pennsylvania). It further resulted in a revolving door at the National Economic Council (NEC), with highly regarded chairman Gary Cohn out, replaced by the well-known economist and policy guru Larry Kudlow.

Weak net trade hurt fourth-quarter GDP It grew by a disappointing annualized pace of 2.5% versus the third quarter’s 3.2%. But domestic final sales (GDP minus the extremely volatile net trade and inventory categories) grew 4.3% in the fourth quarter on a quarter-over-quarter basis, the fastest rise in domestic demand in more than three years, versus 1.9% in the third.

What went wrong? The dollar lost nearly 22% of its value versus the euro over the past 14 months, from 1.03 in January 2017 to 1.26 last month. In conjunction with solid overseas demand, exports rose 7.1% in the fourth quarter versus 2.1% in the third quarter, adding 0.84 percentage points to GDP growth. But imports soared 14% in the fourth (largely due to strong U.S. economic growth and rising demand for foreign goods), versus a decline of 0.7% in the third, which subtracted 1.97 percentage points from fourth-quarter GDP. So, net exports declined by $652.2 billion, subtracting 1.13 percentage points from GDP.

In January, exports eased 1.3% from December’s record $203.6 billion. But imports were essentially flat at a record $257.5 billion, resulting in January’s increasing trade deficit.

Negotiating ploy? Trump responded to this downbeat economic news by imposing 25% and 10% tariffs on imported steel and aluminum, respectively. U.S. Customs and Border Protection authorities can begin collecting the tariffs Friday, although U.S. companies that use the imported metals can seek exclusion from the tariffs. The Trump administration also has indicated it may allow carve-outs for specific countries, too. It already has excluded Canada and Mexico as the three countries renegotiate the North American Free Trade Agreement (Nafta). While the Trump tariffs have sparked fears of a self-inflicted trade war with the potential to damage economic growth here and abroad, we believe this is a negotiating tactic intended to extract better trade terms from Mexico and Canada.

As a rule, we prefer open, tariff-free trade. We believe in the economic theory of comparative advantage, in which countries that can produce particular goods and services at a lower opportunity cost trade with other nations from their surplus. The U.S. government's position is that some countries, such as China, are subsidizing the cost of their domestic production of some goods, such as steel, and are then dumping them on the U.S. at a below-market price, thus impairing our domestic production. We believe that Trump is attempting to level the playing field.

PA 18 We think it was no coincidence Trump announced the tariff plans just ahead of a razor-thin special election for an open seat in the 18th Congressional district in Pennsylvania between Democrat Conor Lamb and Republican Rick Saccone. Trump took this district by 20 points in 2016, so political analysts point to the tightness of the race as a referendum on his presidency and a predictor of upcoming midterm elections.

The preliminary count shows Lamb won by fewer than 700 votes out of approximately 228,000 cast. In our view, the more charismatic candidate Lamb simply ran a better, more energetic campaign. An ex-Marine and former federal prosecutor, Lamb made clear early in his campaign that he opposed Nancy Pelosi and supported tariffs, undermining the wave of “he’s not one of us’’ attack ads funded by outside groups. His race likely will serve as a useful template for Democrats running in Republican districts in the midterm elections. 

Gary Cohn resigns Cohn made it known he felt last summer’s race riots in Charlottesville, Va., distasteful. But he chose not to resign as NEC chair because he had not accomplished his singular goal of tax reform. When that passed, we expected Cohn to resign early this year, and it appears he chose the tariff situation as a convenient excuse. He did an excellent job, in our view, and his wise counsel will be missed.

Larry Kudlow replaces Cohn The Trump administration selected Larry Kudlow as the next NEC chair. Kudlow is a superb choice. As a chief economist at Paine Webber, Bear Stearns and Montgomery Securities, he was a Wall Street rock star early in his career. Later, he served successfully in the Reagan administration as an undersecretary to David Stockton in the Office of Management and Budget. More recently, he hosted a popular economics program on CNBC that ran for a decade, “The Kudlow Report,” as well as a nationally broadcast radio program. As a free-trade, King Dollar advocate, Kudlow will provide Trump with sage, unvarnished advice on the current economic debates.

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