Further Confirmation the Stock Market Has Gotten it Right

For many years protectionists bemoaned the American economy’s Balance of Trade deficit. This figure constantly reflected that we imported far more goods than we exported, which fueled the argument that unfettered trade was unfair and needed to be restricted.

Economists long countered that a trade deficit wasn’t a sign of impending doom but merely reflected dollars in overseas hands that would have to be brought back to our shores and invested in our domestic economy, a sign of an increasingly interconnected world.

They also argued that, given world trade patterns, a shrinking deficit would bode ill for the US economy.

Over the last year protectionists have gotten a chance to see up close what type of economic conditions are reflected by a sharply smaller deficit. We’ve experienced a painful recession as it has shrunk from around $65B to under $30B. In June it was just $27.5B.

The trade deficit was driven by a number of factors. One key was our need for imported oil given our obstinate refusal to expand domestic exploration and production. That meant we needed to let other countries bring oil to market for us.

And, admittedly, Asian economies with a mercantilist approach to growth managed their currencies to support their “export” model of development. Americans had a party with this paradigm as we were the beneficiary of cheap money and cheap goods that fueled significant growth and considerably raised our standard of living. It also, of course, led to the series of bubbles we have experienced this decade, from stocks to real estate to commodities.

The shrinking deficit was driven by the reversal of these trends. But after falling precipitously last autumn and winter to below $30B it appeared to have stabilized this year, holding under $30B from February through June. Now the report for July, released this morning, reflects the largest monthly gain since February 1999, rising 16.3% to $32B.

The report gives real reason for enthusiasm. Increases in automotive and oil imports were expected, given the Cash for Clunkers program and the rising price of oil. But oil was not a significant contributor to the increase and the increase is far more than a bump from the artificial Clunkers stimulus. Instead the report was a surprise because of import growth in other sectors that had been considered moribund, most notably in consumer goods.

This is likely a harbinger of a better than expected Christmas season and better than expected growth in the entertainment sectors (think restaurants and travel) and is yet another confirmation of what the stock market rally has been telling us the last six months: that growth is coming back.

While the rising deficit is good news it is unlikely to lead to deficits anywhere near as large as we saw in the past. The falling dollar will impede American’s hunger for imports and also force a change in the focus of Asian economies, making them focus more on internal development and less on nurturing industry for the sake of overseas sales. The result will be a healthier and more sustainable mix of world trade.

But for now the rising balance of trade deficit indicates the world is on a nascent growth track. But you knew that already. The stock market has been telling you so.