That old investor worry, the US trade deficit, may be coming back into focus. The threat had been receding for six months. The deficit dropped by 16% between August 2006 and February of this year. But the gap jumped 10% in March, to $64 billion (Rs2.62 lakh crore), well above expectations.
It’s only one month’s data, and there are mitigating factors, most notably an improbable decline in aircraft exports. But the increase is improbable in the current economic environment—sub-par increases in the US consumption and accelerating growth in most of the rest of the world. That divergence should have pushed the trade gap down, but in March, imports actually increased four times faster than exports.
The trade deficit started to trouble some investors way back in 1999, when the gap climbed to 2.5% of the US gross domestic product (GDP), compared with the current 5.5%. Then, the worry was that the scale of the deficit might scare the US’ trading partners, leading them to dump their dollar holdings. That would put the greenback in a tailspin and wreck balance sheets around the world. But the shift away from the dollar has proven very slow.
The new concern is that all those trade dollars coming out of Asia and the oil exporters are supporting the excess of global liquidity. The dollars generated by the US trade deficit may only account for 2% of world GDP, but almost all of them are invested in financial markets, where the flow of funds is multiplied into a flood of credit. In turn, the ease of borrowing allows investors to pay up for all sorts of assets, from houses to loans.
By this logic, the prospect of a renewed increase of the US trade deficit is good news for global investors. But financial gains created by industrial weakness aren’t exactly healthy. Asset price inflation means that capital markets are outperforming the real economy. That can go on for years, but not forever. When the rebalancing comes, investors are likely to regret their trust in those free-flowing foreign dollars.