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50,000 Is a "Surge"; 20,000 Is a "Wave"

The Trade Deficit May Have Peaked, But the Current-Account Deficit Probably Has Not

Brad Setser does not expect the U.S. trade deficit to fall much:

RGE - Two reasons why I am cautious about predicting a big turn in the trade deficit: A rising fraction of the Toyotas sold in the US are now made in Japan. The Journal:

Toyota has said it aims to produce in North America two-thirds of the overall number of vehicles it sells here. Its chairman, Fujio Cho, has said the ratio ideally should reach as high as 75%. But rising imports have sent Toyota's North American production ratio slipping to 54% in 2006.... According to an internal Toyota document reviewed by The Wall Street Journal, Toyota's North American production ratio, or "NAP ratio," will remain around 55% this year, 54% next year and 57% to 62% in 2009. It doesn't expect it to recover to 60%-65% levels until 2010 when its eighth North American site ramps up to its capacity.

Jim Press, the senior-most American executive at Toyota, said last month that Toyota's North American production ratio is slipping because of a sudden surge of demand in the U.S. for smaller fuel-efficient cars that coincided with a run-up in gasoline prices last year. The NAP ratio slide is "temporary" as Toyota is meeting an unanticipated rise in demand for small cars, which Toyota doesn't produce in North America....

And with the yen at 115-120, I don’t see why Toyota has a strong incentive to ramp up US production all that rapidly. That matters. Remember, a surge in transplant production after the yen rose in the 80s was a key reason why the US trade deficit came down back then. And in some sense the rising share of toyota’s imported from Japan is indicative of a broader problem. All global auto companies more or less had the same strategy: they made big SUVs in the US and made small cars outside the US. That has left the US with a gap between the capital stock it needs and the capital stock it has... in this case, one specific to the automobile industry.

The imported content of some US exports looks set to rise. No industry generates more exports than aircraft; Boeing’s recent run of success one of the reasons why US exports are rising strongly. But a rising fraction of Boeing’s future production likely will be composed of imported parts. Those gangly 747u’s aren’t just going to be used to fly components from Wichita to Seattle.

One other thing too. Boeing exports have gone up (way up) in part because US airlines haven’t been buying planes. That freed up Boeings for export – and also reduced US imports of Airbuses. By my count, only 2 of the 91 widebodies Boeing delivered in 2006 went to US airlines. At some point, though, US airlines will have to renew their fleets.

I usually focus on financial variables, but reducing the trade deficit on a sustained basis ultimately requires real adjustment – a higher US content of the average car sold in the US market; rising US content in the United States biggest export industry and so on. Right now, the evidence supporting such changes is decidedly mixed.

And yes, reducing the trade deficit also requires some reduction in the pace of overall US demand growth, something that also hasn’t happened on a sustained basis. And if the US avoids a housing-induced recession on the back of the ever resilient US consumer, well, it might not happen in 2007 either. The world economy will revert back to growing the way it has grown for most of the past five years -- on the back of strong US (and increasingly European) consumer demand, Asian supply and Asian financing.

The implicit prediction is that when central banks stop buying dollars the fall in the dollar is going to be very large.