The globalization scheme consists of the persistent effort to lower the barriers that are preventing the free flow of goods, services and capitals across national boundaries. The proponents of this scheme claim that the free trade regime will eliminate inefficient producers and every country can concentrate on the production of its own expertise so that the whole world will benefit economically. This simplistic view is basically flawed since it assumes that the modern human race is not homogenous in the skills of producing goods and services. Those experts are assuming implicitly that the population in developed regions is more intelligent than the population in the under-developed regions so that by moving labor intensive and low skill productions to under-developed countries, developed societies can concentrate on the cutting edge high tech production of goods and services to continue to prosper and play the leading role of global economy. However, modern science has revealed that DNA of modern human race is very homogeneous and no large group of population is more intelligent in average than any other such groups, though within each group there is apparently a distribution of people of varying level of intelligences. The observable disparities in the skills of production among various regions of the world are mostly due to social and environmental conditions. This means that if the conditions are right, developing countries can equally produce everything that is produced in the developed world. Thus the efficiencies of production are nothing but the disparities of cost of production that is determined by the labor costs, the level of environmental controls, social stability, other social conditions and currency exchange rates. For example, anything produced in The United States of America (abbreviated as USA or US throughout the remaining part of this article), including most cutting edge military hardware, can probably be produced in China and India more cost effectively today. This also means that until the costs of production equalize, jobs of producing goods and services will continue to flow from the higher cost developed world toward the lower cost developing world under the globalization scheme. Since the population in the developing world is much larger and growing faster than the population of the developed world, the process of equalizing the cost of production takes a long time, probably quite a few decades to complete.
A currency market free from any kind of intervention of various governments provides a moderating force to the job flow from the developed world toward the under-developed world. As the job flowing process advances, the developed world will increasingly experience higher trade deficits and the supply of their currencies in the currency market will increase accordingly. This over supply of the currencies of the developed world will push down the value of their currencies against the currencies of the under-developed countries, and thus speeds up the process of equalizing the cost of production. However, the current globalization scheme allows governments to retain full controls of the exchange rates of their currencies. The under-developed countries have strong incentive to hold their currencies low compared to the currencies of the developed societies through massive currency market manipulations so that they can prolong the process of job flow beyond the natural cycle if the currency market is left free from any government manipulations.
Three developed economic entities of the world, USA, Europe, and Japan are responding to this reality of globalization and the accompanying job outflow process quite differently. USA, as the leading promoter of the globalization scheme, has been implicitly and explicitly encouraging the developing countries to manipulate the currency market to make US Dollar vastly overvalued and to make US trade deficit expand rapidly. US administrations have been engaging in this seemingly contradictory behavior from the discovery of a serious error of modern economics about the effect of trade deficit. Modern economics claims that trade deficit depresses the growth of real Domestic Gross Product (abbreviated as GDP). In reality running trade deficit is equivalent to borrow from foreigners and spend, so the consumers in a trade deficit country can spend much more than the amount that they actually produce, and thus trade deficit will push up GDP in short to medium terms through increased personal consumption, not depress GDP as modern economics is claiming. Reagan administration in the 1980's used this magic of trade deficit to sustain a long economic expansion in spite of run away government budget deficit that would short circuit an economic expansion under a normal circumstance. It was only under the immense political pressure from US manufacturing sector that was hurt severely by the rapidly expanding trade deficit, Reagan administration forced Japan, the leading cause of US trade deficit at that time, to massively upwardly revaluate Japanese Yen vs. US Dollar. After that massive revaluation of Yen, US trade deficit started to shrink, and that shrinkage of trade deficit immediately caused the stock market to crash in 1987 and eventually ushered in an economic slowdown around 1990. Clinton administration in 1990's had explicitly encouraged the manipulation of currency market to push dollar to a vastly overvalued situation under the name of "strong dollar" policy. As the result US trade deficit expanded rapidly anew, creating a very long lasting economic boom coupled with strong disinflational trend, a condition deemed impossible by the followers of the erroneous modern economics. During that Clinton era boom, the age of internet dawned. Many analysts attributed the long lasting boom as the result of the emerging high tech advancement and claimed that the boom would never end as long as the advancement of high technology continued. However, the vastly overvalued dollar triggered severe reaction and dollar fell sharply in the summer of 1998 and again in the summer of 1999, and US trade deficit started to shrink by late 2000. As the trade deficit shrank, the high tech stock bubble burst and US economy slowed down, though the technical side of high tech industry has kept uninterrupted advance until today. This shows vividly that the Clinton era boom is again the result of the run away trade deficit, and the advancement of high technology probably only played a minor role. The current US administration, facing a renewed and more vigorous expansion of the trade deficit that has reawakened US economic expansion since the middle of 2002, is only paying lip service against the currency market manipulation of Chinese government to suppress the natural upward advance of Chinese Yuan against US Dollar, an unavoidable outcome due to the outsized trade surplus of China against USA. US administration is hesitant to take any real meaningful action to force Chinese government to back down from the currency market manipulation. This attitude of the current US administration is again due to the fear that a meaningful upward revaluation of Chinese Yuan will shrink US trade deficit and ignites another collapse of stock market and an economic slowdown during its rein. This kind of fear of the shrinkage of trade deficit and the resulting economic slowdown will be inherited to the administration after administration to come, and it will push US trade deficit higher and higher until USA is transformed into a society as depicted in Article 7 posted in this website under the title of "globalization utopia". This kind of imprudent behavior to use trade deficit to boost consumption and GDP, of course, cannot continue forever. As trade deficit increases, adverse effects on the economy will intensify and will lead to an eventual collapse of the whole system. That is why we study the effect of trade deficit on US economy and the developing adverse effects in this article extensively.
Japan has been coping with the reality of globalization by reducing itself to a developing country to slow down the job-loss process. It has reduced its short-term interest rate to zero, and has conducted massive currency market manipulations to push Yen to a vastly undervalued situation vs. Dollar in order to continue its export oriented mercantilistic policy. Contrary to the dogma of the modern economics that lower interest rate always induce more spending, zero interest rate in Japan has literary devastated the desire of Japanese consumers to spend, and has pushed Japan into a decade long deflation and stagnation. This is due to the reality that most Japanese workers are forced to retire at age 55, and they must save heavily to guarantee themselves reasonable living after retirement. Thus zero interest-rate means no compounding interest income, more saving, less spending, and deflation and stagnation. The artificially lowered Yen then induces a massive trade surplus for Japan. The massive trade surplus is equivalent to export Japan's hard earned domestic saving to trade deficit countries and let consumers of those trade deficit countries to spend. The repeated consumption booms in USA based on the run away trade deficit are heavily relied on this self-imposed sacrifice of Japan. However, considering that per capita GDP of China is still about 5% of that of Japan, Japanese government needs to do much more to lower the living standard of people of Japan, and let the environment of Japan be more polluted in order to equalize the cost of production with China and India. We will be touching upon the current situation of Japan in a later section, but a detailed update of Article 1 of 1998 about the situation of Japan will be reserved to a later time.
Europe's response to the situation of globalization is between two extremes of USA and Japan; it is literary doing nothing special. The jobs of producing common goods in Europe are flowing out to developing countries, but the trade balance of Europe is held at near neutral level by its traditionally strong luxury goods exports, especially its automobiles. However, with higher price and lower quality, the aura of past excellence will gradually fade away even among the oil riches and the riches of the east coast of USA, and Europe's trade balance will gradually deteriorate. The neutral trade balance of Europe at present time means that Europe cannot use trade deficit to boost its consumption. However, the workers who lost their jobs due to the outflow of jobs to the developing countries are supported indefinitely by the vast social welfare system, so there is no much social pressure to do anything drastic. Europe is destined to be marred in a slow growth situation for foreseeable future. A thorough study of the situation of Europe is currently not in our agenda due to the continuously changing definition of the Euro region that makes economic data discontinuous and a thorough analysis difficult.
In section 2 of this article trade data of Japan and USA are analyzed to show that the total amount of goods trade is not correlated to the growth of real GDP. In section 3 the logic behind the claim that trade balance influence GDP growth in the globalization era is summarized and the relation of trade deficit and real GDP growth of USA is studied in quarterly intervals. This study is both an update and a refined approach to the study of Article 2 that only deals with annual interval of the data. The refined analysis reveals finer structures of economic slowdowns, and will help earlier identification of the changing scope of US economy. Section 4 is devoted to the study of ill effects caused by economic expansions relied on the run away trade deficit. Future projections of the evolution of US economy are made in the final concluding section.
2. Total trade of goods is not correlated to the growth of real GDP
Proponents of the globalization scheme claim that expanding total trades under the scheme benefit all the participating countries economically. This claim is true for the developing countries that are adopting the economic development model called "Taiwan model" (see Comment 26 posted on this website for details), like China, but the claim is in serious doubt with regard to developed countries like Japan and USA. In the right GDP and trade data of Japan are shown. The purple curve at the top of the graph is the annual real GDP growth rate from 1955 to 2004. The black curve is the ratio of total goods trade to nominal GDP expressed in percentage. The blue and the red curves are the ratios of goods export and goods import to nominal GDP respectively, and the green curve at the bottom of the graph is the ratio of trade balance of goods over nominal GDP. We first direct the attention of readers to the trade balance data, the green curve at the bottom. It is only since the early part of 1980's Japan has started to run steady trade surplus, long after Japan has become a developed country. This means that Japan has not risen through "Taiwan model" that is followed by China at present, and by Taiwan during 1970's and 1980's; some analysts are mistakenly claiming that the rise of China is similar to that of Japan, a complete misunderstanding of the economic facts. The period from 1950 to 1972, before the onset of the first energy crisis, was the golden age of Japan's growth with the growth rate of real GDP averaging about 10% a year. During that era, the ratio of total trade of goods to nominal GDP was oscillating between 16% and 19%, and the trade balance oscillated between negative and positive to create a wash as a whole. From 1974 to 1984 the ratio of total goods trade to GDP jumped to 22% a year in average. The sharp increases of the ratio of imports to GDP at 1974 and 1980 were due to two energy crises and the escalated costs of oil imports, but the high ratio of total goods trade to GDP during that period was mainly the result of strong goods exports. As the ratio of total trade to GDP jumps, the growth rate of real GDP of Japan sank to about 5% a year, in total contradiction to the claim of globalization enthusiasts. The ratio of total goods trade to GDP sank sharply starting from 1985, and then stabilized until 1990, followed by another fall until 1993, whereas the growth rate of real GDP strengthened in the latter half of 1980's. From 1994, the ratio of total goods trade has been rising, but the growth rate of real GDP has been oscillating downward. Only in a short period, from 1991 to 1993, the falling ratio of total trade over GDP was accompanied by falling growth rate of real GDP. For most of the other periods, the anti-correlation between the growth rate of real GDP and the ratio of total trade to GDP was the norm. Thus the claim that the growth of total trade boosts the growth of real GDP is simply not true in the case of Japan.
GDP and trade data of USA are plotted in the graph at the left. The top black curve is the 2000-chained real GDP of USA expressed in log-10 scale. The second black curve is the ratio of total goods trade to the nominal GDP expressed in percentage. The red curve and the third black curve are the ratios of goods import to nominal GDP and goods export to nominal GDP expressed respectively in percentage. The blue curve at the bottom is the trade deficit of goods over nominal GDP expressed in percentage with trade surplus periods shown as negative values. Data in this graph are quarterly interval values and the real GDP data are annualized quarterly values. In this USA graph, the ratio of total goods trade can be said is rising toward the right in average, not like the case of Japan that the ratio is slanting down as time passes. Thus we may inclined to say that the gradually rising ratio of total goods trade over GDP is somewhat correlated to the generally rising real GDP. However, three peaks of the ratio, at 1974, 1980 and 2000, all occurred during the visible stagnation phase of real GDP. Those three peaks were due to the surge of both import and export ratios, as if indicating that overheated trades rather caused economic slowdowns. Furthermore, the valley of the ratio of total trade to GDP from 1983 to 1987 coincided with the strong growth of real GDP. The phase of long sideway period of the ratio, from 1988 to 1994, encompassed both the growing and the declining periods of GDP. On the other hand, the rise of the ratio since 2002 has synchronized with the rise of real GDP. From those observations, the question whether there is correlation between the ratio of total goods trade over GDP and the growth of real GDP cannot be answered by the USA graph alone. We need to go into the explicit correlation study to entangle the issue.
The figure at the right is the correlation graph between the growth rate of real GDP of USA and the ratio of total goods trade to nominal GDP. The red dots are the annual value and the green line associates each red dot with the year it represents. A blue line connects a red dot with the one of the previous year. The portion from year 1982 to 2004 is plotted in the top portion of the graph and the data from 1953 to 1982 are shown in the bottom half of the graph. The data points from 1953 to 1965 were within a narrow band of the ratio of total goods trade to nominal GDP, from 6.1% to 6.6%. Only after 1965 the ratio started to shift higher toward the left side of the graph. After 1972, the ratio jumped big, but with the growth rate of real GDP slumping sharply. As the rises of the ratios of exports and imports of goods to GDP in the previous graph show, the rapid expansion of the total trade from 1972 to 1974 was due to the rapid expansions of both imports and exports, resulting in a heightened inflation that brought on the first energy crisis and the sharply slumping growth rate of real GDP. The data points from 1975 to 1978 were the only rare occasion that the rising of the ratio of total goods trade to GDP synchronized with the rising growth rate of real GDP, but the further expansion of the ratio of total goods trade to GDP from 1978 to 1980 brought on more inflation and sharply lower growth rate of real GDP again and plunged the world into the second energy crises. Shifting to the right-hand portion of the top graph, data points from 1982 to 1987 are clustered around the ratio 14%. This means that the golden years of Reagan era economic expansion was achieved with a stable ratio of total trade of goods to GDP. Only after the sharp downward revaluation of US Dollar against Japanese Yen in 1985 that started to push US exports sharply higher starting from 1987, the ratio expanded until 1989, but again pushed the growth rate of real GDP lower and finally into the economic slowdown of 1990 to 1991. The recovery from 1991 to 1992 and 1993 did not require any expansion of the ratio of total goods trade to GDP. The expansion of the ratio from 1993 to 1995 did not bring on a significant economic slowdown, but the golden era of Clinton expansion, from 1995 to 1999, was again carried out with the ratio of total goods trade to GDP stayed in a narrow band of 18.1% to 18.5%. The rapid expansion of the ratio from 1999 to 2000 once again brought down the growth rate of real GDP. As the ratio retreated from its peak, US economy slumped further into 2001. Only the recovery starting from 2002 brought the ratio gradually up through 2003 and 2004. The official data point of 2005 is still not in so is not plotted in the graph, but the point of 2005 should be around 20.5% for the ratio with the growth rate of real GDP stay between 3.5 to 4.0%. From this detailed correlation study, we can confidently say that the positive correlation between the expansion of total trade to GDP ratio and the growth rate of real GDP is just a wishful thinking for the economy of USA, too.
3. The correlation between trade deficit and GDP growth of USA: a refined analysis
After showing that the claim that the growth of total trade of goods boosts real GDP is false for two matured economic entities, Japan and USA, we need to go back to the themes of Article 1 and Article 2 posted on this website. In Article 1 the falling growth rate of Japan since 1992 is attributed to the disastrous policy of zero interest rate. As mentioned in the introductory section, zero interest-rate has discouraged consumption and induced deflation and stagnation, a total contradiction to the claim of modern economics as long as Japan is concerned. On the other hand zero interest rate and massive currency market manipulations in the hands of Japanese government has pushed Japanese Yen into a vastly undervalued situation, and has ignited the explosion of Japan's trade surplus. For a matured economic entity like Japan to run sustained large trade surplus is nothing but to push its domestic savings to trade deficit countries to be spent meanwhile assure further the decline of consumption in its own society; this misguided zero interest rate policy is the basic reason of Japan's persistent stagnation, not from the economic structural problems as many economists try to claim. However, a refined analysis and the update to Article 1 of 1998 will be shown in a separate article in a later date. In this section we will concentrate our attention to the theme of Article 2 that US prosperity since the 1980's is mainly based on the run away trade deficit.
Before looking into USA data, we summarize the logical argument why the simplistic claim that imports hurt GDP and exports help GDP is not warranted. The argument presented here has been first aired partly in Articles 1 and 2, and partly in many Comments posted on this website. The simplistic view of modern economics about the role of trades on GDP arises from a superficial reading of the way GDP is compiled. As we know, GDP stands for The Gross Domestic Production. However, if we try to compile the total domestic production by chasing the values added to a product at each stage of its production, the job becomes very tedious. Let us take a simple iron skillet as an example. If we want to calculate its value from the production side, we need first to calculate how much raw iron core is used for the skillet, then to calculate the cost of producing that amount of iron core by the mining company, the value added by the iron mill to turn the iron core into useful raw iron, the value added by the factory that produced the skillet from raw iron, the value added by each dealer that handle the skillet through the chain of commerce, and finally the value added by the retailer that sold the skillet to a consumer. It is much easier to look at the final price at which the consumer bought the skillet and call it the value of the skillet instead. GDP compilation uses the latter way to tabulate the total values produced domestically. The biggest component of GDP is called "personal consumption expenditure" or "final sale"; it literally adds up the prices of all the retail items sold to consumers. The second component of GDP is called "private fixed asset investment". It is the sum of "residential fixed asset investment", "non-residential fixed asset investment" and the accumulation of inventories. The "residential fixed asset investment" is the sum of all the new private houses constructed during the period of tabulation, usually within each quarter. "Non-residential fixed asset investments" is the sum that private businesses spent in buying new equipment and software, and in construction of new buildings and factories. The third component of GDP is the total expenditure of governments. The sum of these three components may be called the Gross Domestic Consumption. For an isolated society that does not trade with other countries, this Gross Domestic Consumption is equal to its Gross Domestic Production. However, when international trade is involved, those two are not equal. For example, let us assume that the iron skillet considered earlier is imported and that the price when this iron skillet passes the custom is $5. The tabulation of personal consumption considers this iron skillet to be contributing $20 to the account and thus $20 to GDP, but actually the first $5 is not produced domestically and only $15 should be the contribution to GDP. That is why GDP tabulation must subtract this $5 in a separate component called "imports". Exports raise a problem too. An item produced domestically and exported away is not counted in any of the three components discussed before, but the item is clearly produced domestically and should be included in GDP. That is why in GDP tabulation total amount of exports is added to GDP in another separate component called "exports". The sum of three major components, that is, personal consumption, private fixed asset investments and government spending, minus total imports of goods and services, and plus total exports of goods and services make up the GDP. GDP compiled that way is called the nominal GDP. Applying inflation adjustments to the nominal GDP, we arrive at the real GDP. The simplistic and erroneous view that imports hurt GDP and exports help GDP is based on the superficial reading of the last two items, imports and exports, in GDP tabulation, since they create an illusion that more imports will subtract more from GDP and more exports will add to GDP more. The error in this simplistic view should be obvious from the import side. In the case of the iron skillet, if it is not imported, $5 does not need to be subtracted from GDP, but the account of personal consumption will lose $20 from the sale of the skillet to a consumer. Thus the import of the iron skillet will add $15 ($20 in personal consumption account minus $5 from import-export account) to GDP, not minus $5 as the simplistic view is claiming. However, to estimate the exact amount an imported item will add to GDP we also need to take into account the effect of the import on domestic production, and the analysis is not straightforward. In the next paragraph we will be looking into the situation of imports in detail. The impact of exports on GDP is equally complicated as the case of imports since exports may take something away from the consumption of domestically produced goods, and can hurt GDP of a matured economic entity instead of helping its GDP. We will be analyzing the case of exports in the paragraph after the next paragraph.
Let us consider an iron skillet that costs $6 to produce domestically, and is sold to a consumer for $20 after going through the retail chains. In this case GDP gains $20 from this iron skillet and the retail chains generate an income of $14 = $20 - $6 by handling this iron skillet. Suppose that a foreign manufactured iron skillet of similar quality can be imported for $5. If the retail chains handle this foreign manufactured iron skillet, they can generate an income of $15 = $20 - $5. Thus the retail chains will flock to import the foreign manufactured iron skillet and put the domestic manufacturer of the iron skillet out of business. By importing the iron skillet, GDP gains $15 as discussed in the previous paragraph, but GDP loses $20 from the loss of the domestically produced iron skillet. However, the story does not stop here and the question is what the domestic labor force and the domestic capital idled by the imported iron skillet are going to do. According to the enthusiasts of the globalization scheme, by exporting the low skill job of manufacturing the iron skillet the domestic labor resource of producing the iron skillet can now be redeployed to higher skilled jobs. Suppose we subscribe to this rosy view and assume that the labor resource released from the bondage of making the iron skillet now generates $30 worth of goods or services in high tech area. Thus GDP will gain $25 from importing the iron skillet, that is, $15 gain from the straightforward computation of GDP, $20 loss from the loss of domestic iron skillet, and $30 gain from the newly deployed labor resource. However, in reality in USA, the domestic labor idled from the manufacturing of the iron skillet will only be able to find lower paid and lower skill jobs that foreigners either unwilling or incapable to take; let us assume in this pessimistic case that the redeployed labor is able to generate only $10 worth of goods and services. Even in this pessimistic case GDP will gain $5 by importing the iron skillet, that is, $15 gain from the direct calculation of the import, $20 loss due to the loss of the domestic iron skillet, and $10 gain from the redeployed labor. Only in an economic entity with hardened artery that the redeployed labor can only generate less than $5, GDP will start to lose by importing the iron skillet. In the extreme case that the displaced domestic labor is idled forever and no redeployment will take place, then GDP will lose $5 by importing this $5 iron skillet as the simplistic view claims. The present day situation of USA is still far from the extreme that imports will depress GDP. Thus more imports means more consumption boom and higher GDP. Japan is running a hefty trade surplus, and Europe is still running a slight trade surplus, too. The argument that imports will boost GDP is rather mute for Japan and Europe.
To discuss the impact of exports on GDP, let us consider a matured economic entity with a currency called "Yen". We assume that all the labor and capital resources of the economic entity are fully deployed. The economic entity can have its imports, exports and what so ever trade balance it is running at the moment of consideration. Also let us assume that there is an iron skillet produced domestically in the economic entity; it costs 500 yen to manufacture, and is sold to a consumer for 2000 yen. Thus one iron skillet contributes 2000 yen to the GDP. Suppose the exchange rate of Yen to Dollar is 100 Yen per Dollar, and on the international market the iron skillet can be sold at $5. Under those conditions, the domestic producer of the iron skillet has no incentive to export the skillet, and everything is in equilibrium. Now suppose that the government of the economic entity is dissatisfied with the sluggish growth of real GDP and wants to stimulate the growth of its economy. The officials of the government decide to increase their exports since modern economics says that more exports means more GDP growth. It is difficult for the economic entity to increase export under the condition of equilibrium unless some drastic action is taken. Therefore, the government sells a large amount of newly printed Yen for Dollar until the exchange rate becomes 120 Yen per Dollar. The domestic producer of the iron skillet realizes that if he exports the iron skillet, he can fetch (5 dollar) x (120 Yen/Dollar) = 600 Yen, whereas he can only fetch 500 Yen if he sells the skillet domestically. Thus the iron skillet is exported. GDP lose 2000 Yen in the "personal consumption" account, and gain 120 x 5 = 600 Yen by exporting the skillet. Thus GDP will be reduced by 2000 - 600 = 1400 Yen due to the export of this iron skillet. Since the domestic labor resource is fully deployed already, the manufacturer is not able to hire more workers to make another iron skillet for domestic consumption, and the reduction of 1400 Yen from GDP is final. If the economic entity has idled labor resource, the situation will be quite different. The domestic manufacturer does not need to abandon the domestic sale of the iron skillet, since he can borrow yens released to the market from government's currency market manipulation and hire more workers to make more skillets for export. In this case GDP will gain from the increased exports. This line of consideration explains roughly the situation of Japan throughout the last decade. At the time when Japanese government has started currency market manipulation to push Yen lower against US Dollar and to spur the explosion of Japanese exports in the 1990's, Japan's labor was fully engaged. Thus as Japanese exports increased, Japanese GDP weakened. However, after many years of this self-inflicted misery, Japan now has some idled labor resource, just like a developing country. That is why Japanese economy looks like revitalizing as exports surge in the past few years.
Let us now study the data of USA to see how the growth rate of real GDP is correlated to the ratio of trade deficit to GDP. In the graph at the right, correlations between the real GDP growth rate and the ratio of goods trade deficit to nominal GDP (abbreviated as trade deficit ratio from this point on) are plotted. Four-quarter moving average of the real GDP growth rate and four-quarter moving average of trade deficit ratio are used to smooth the jaggedness of the actual data. The data from the 4-th quarter of 1989 to the 3rd quarter of 2005 are plotted in the top portion of the graph, and the data from the 4-th quarter of 1956 to the 4-th quarter of 1990 are plotted in the lower portion of the graph. The vertical scale is for the growth rate of real GDP and the horizontal scale is for the trade deficit ratio; both the vertical and the horizontal scales are expressed in percentages. It should be noted that in the horizontal scale, the data of the quarters with trade surplus are expressed as negative numbers. The green line associates the 4-th quarter data of each year with the two-digit number identifying the year. The blue line connects the quarterly data point with the data point of the previous quarter.
The data from 1956 to 1967 are clustered around the range of -1.5 to -0.5 of the trade deficit ratio, and the tracing blue lines do not seem to have any pattern of regularity. That means the lack of correlation between the growth rates of real GDP and the trade surplus ratio during that period. In the period from 1968 to 1976, the data points have shifted toward the left, and start to form an anti-correlation between the growth rate of real GDP and the trade balance ratio, that is, real GDP growth rate increases as trade deficit ratio increases and vice versa. The data points for the period of 1977 to 1983 have shifted toward the left further and form a clear anti-correlation between the growth rate of real GDP and the trade balance ratio. The features discussed up to this point are the same as discussed in Article 2. This means that refined analysis based on four quarter moving averages does not add more insight than the annual data based analysis of Article 2 for the period of 1956 to 1982.
From 1983 to 1990, this refined analysis reveals a large counter-clockwise curve with a flattish clockwise loop added to its leftmost portion. By 1982 The Federal Reserve Board (abbreviated as FED) under the leadership of Paul Volker had brought down the hyperinflation of late 1970's and Federal Fund's rate had started to drop precipitously as shown in the graph at the left. The growth rate of real GDP is bound to rise quickly under such a condition. On the other hand Reagan administration's massive government spending and their policy to fund the run away federal budget deficit through the offerings of treasury debt instruments, not just printing money as Carter administration had done, had kept long-term interest rate high. This high real long-term interest rate in US in turn sustained US Dollar at a very overvalued level (see the graph at the left), and US trade deficit had started to expand rapidly, further stimulating consumer spending and the growth of real GDP while holding inflation low from foreign competition. Thus the rising goods trade deficit ratio and the rising GDP growth rate from 1982 to the first quarter of 1984 in unison formed the rising part of the counter-clockwise loop under consideration. Scared by this over reaction of the economy and the run away budget deficit and trade deficit, FED had started to raise Federal Fund's rate again from 1983 but this monetary tightening did not slow down the rapid expansion of trade deficit ratio. The drop of the real GDP growth rate to near 5% by the end of 1984 from 8% at the beginning of 1984 probably was not the result of the minor FED tightening but a natural behavior of the economy, since a growth rate of 8% exceeded the maximum potential growth rate of a matured economy and cannot be sustained for a long time. The natural dropping of the growth rate of real GDP coupled with continuing expansion of the trade deficit ratio caused the counter-clockwise loop to spiraling down from the first quarter of 1984 to the end of 1984. As US trade deficit expanded rapidly, political pressure within US mounted, especially from the manufacturing industries hit hard by imports from Japan. US government exerted strong political pressure on Japan to force Japan to rein in exports to US under voluntary quotas. That move had slowed down the expansion of US trade deficit from the end of 1984 to the end of 1985, bringing down the growth rate of real GDP with it. In 1985 massive devaluation of US Dollar against Japanese Yen, as shown in the graph at the left, was agreed upon, the political pressure on Japan to curtail its exports to US through non-market forces lessened, and US trade deficit expanded anew, forming the rapid rightward expansion of the data points from 1985 to 1986. The dip of real GDP growth around 1986 to 2.5% cannot be attributed to FED tightening since the minor tightening started in 1983 only lasted until the third quarter of 1984; Federal Fund's rate slumped sharply until the third quarter of 1986 as can be seen from the graph at the left. The slump from 1985 to 1986 was due to the fatigue that the relentless expansion of trade deficit since 1982 had finally caused; in other words US economy could not digest such a rapid expansion of trade deficit in such a short time span, and the stimulus from the expanding trade deficit had turned into an indigestion since labor resource idled by imports could not be redeployed so quickly. By 1987 the effect of 1985 massive devaluation of Dollar vs. Yen had set in and the goods trade deficit ratio first stagnated and then started to shrink. As the trade deficit ratio shrank, US stock market crashed. During the period prior to 1987, US export capacity was left undamaged, only temporary idled by the surging Dollar and imports. As Dollar dropped sharply against Yen, exporters revived and hired back laid off workers. This kind of activity did not hurt domestic consumption but added to GDP as discussed in earlier theoretical analysis. That was the reason why as the ratio of trade deficit to GDP retreated toward the right from 1987 to 1988, the growth rate of real GDP was able to hold up for a while. However, as the idled capacity of exporters was exhausted, this GDP boosting effect from exports diminished, the negative effect of decreased trade deficit ratio was felt in full, pulling down the growth rate of real GDP as trade deficit ratio shrinks further and further. Thus US economy entered the recession of 1989 to 1991.
We now move to the right most counter-clockwise loop of the top portion of the correlation graph between the real GDP growth rate and the goods trade deficit ratio. Dollar had stopped falling against Yen in 1988 as the currency market players noticed the fall of US trade deficit at late 1987. The change of trend of trade balance usually trails the turning point of currency exchange rate by about 2 years as discussed in Article 2. Thus the ratio of goods trade deficit to GDP stabilized in 1990. On the other hand FED was scared by the refusal of GDP to slowdown when trade deficit started to shrink in late 1987 as discussed at the end of the previous paragraph, since a persistent strong growth and shrinking trade deficit would have triggered inflation. FED started to raise Federal Fund's rate at the beginning of 1988. The effect of this monetary tightening started to bite in 1989 and 1990. That was why the growth rate of real GDP plunged in 1990 in spite of the stagnated trade deficit ratio. This effect created the left-hand wall of the counter-clockwise loop at the rightmost part of the top portion of the correlation graph. The sharp fall of Dollar since 1985 had made US exports more competitive. As US GDP growth slows, more products became available for exports, and that in turn shrank trade deficit ratio further until the end of 1991. This kind of expansion of exports during a depressed economic condition lifted the economy from the bottom gradually while trade deficit ratio was shrinking. Thus the bottom portion of the counter clockwise loop was formed. FED had lowered Federal Fund's rate aggressively from the middle of 1989 when the economic slowdown became apparent, and the fund's rate crawled at the bottom from 1992 until 1994. That loose monetary policy also helped to lift the economy out of the recession along with the expanding exports. On the other hand by the end of 1991 Japan's economic bubble had burst, and Japanese products rushed out to US market again, overcoming the sharp upward revaluation of Yen that started in 1985 by improved manufacturing technologies. US imports from Japan and Taiwan, the surrogate exporter of Japan at that time, surged, and the ratio of trade deficit to GDP first stopped falling and then expanded anew by the early part of 1992. The renewed expansion of US trade deficit in conjunction with the accommodative monetary policy lifted the growth rate of real GDP. Thus the right hand wall and the top portion of the counter-clockwise loop were formed. The loop started at the second quarter of 1990 and was completed by the third quarter of 1993.
To understand the movement of US trade deficit, we need to study the exchange rate between US Dollar and Japanese Yen, with which another major currency through 1980's and 1990's, German Mark, is more or less synchronized (see Article 3 for the movement of German Mark and Euro). However, to understand the movement of the value of US Dollar vs. Japanese Yen, we need to watch in turn the ups and downs of US trade deficit as well as Federal Fund's rate. The long slide of Dollar vs. Yen had come to a temporary halt in 1988 as US trade deficit started to retreat, and then Dollar rallied for a short while, from the beginning of 1989 to the middle of 1990. As the ratio of trade deficit to GDP stopped falling along the left-hand wall of the counter-clockwise loop of 1990 to 1993, Dollar started to slide again. By that time Federal Fund's rate had been falling rapidly, and further fueled the weakening of Dollar. The renewed slide of Dollar had started at the second quarter of 1990 and continued until the second quarter of 1995. This long slide of Dollar was supposed to slowdown the expansion of US trade deficit from 1992, but did not. That was due to the convergence of several factors. The first was that the end of Japan's bubble had unleashed a flood of high quality Japanese exports; those Japanese exports apparently were able to beat the substantial upward revaluation of Yen and still retained tremendous competitive power. The second factor was that Taiwan reached the end of the era of "Taiwan model" and Taiwan merchants had started to move their factories en masse into China to produce goods to be exported to US. The flow of Chinese made goods into US were not only not affected by the falling Dollar vs. Yen but got a strong push at that time since Chinese Yuan was just vastly devaluated against Dollar and was then pegged to Dollar at the very undervalued level. The third factor was the emergence of South Korea, the latecomer of Asian Tigers, the currency of which was also pegged to Dollar so the falling Dollar vs. Yen did also not affect its exports. As the moderate fall of Dollar from 1990 failed to curb the renewed expansion of US trade deficit, Dollar fell more rapidly starting from 1992. Japanese government intervened in the currency market, trying to stop the free falling Dollar but to no avail. From the beginning of 1994 to the early part of 1995 Federal Fund's rate was raised, but that also was not able to stop the fall of Dollar. The long fall of Dollar eventually halted the expansion of the goods trade deficit ratio and the ratio stayed in the range of 2.3 to 2.6 % from 1995 to 1997. It should be noted that this ratio around 2.5 % is rather small compared to the ratio of 3.4% reached at 1987. This means that US economy was not burdened so much by trade deficit during the period of 1995 to 1997. As the ratio of trade deficit to GDP stalled in 1995, GDP growth slumped. As the growth slowed, exports picked up and further depressed the ratio. Thus a small counter-clockwise loop was formed marking the minor economic slowdown of 1995 to 1996. From 1996 to 1997, the ratio of trade deficit to GDP was stable, whereas real GDP grew at the rate of 4.5 %. During that time Federal Fund's rate was also kept steady at above 5 % level. The GDP expansion of 1996 to 1997 was due to the underlying dynamics of US economy at that time, not from the boost of trade deficit, and also not from the stimulus of loose monetary policy. Dollar reached a historic bottom of 80 Yen/Dollar in early 1995. Bank of Japan took an unprecedented gamble by lowering short-term interest rate of Japan to near zero level. This action unleashed the "Yen carry trade" conducted by speculative and highly leveraged hedge funds; this tactic is to borrow yens at near zero interest rates, sell those borrowed yens for dollars, and uses the dollars to buy high yielding debt instruments of countries whose currencies are pegged to Dollar. Yen carry trades pushed Dollar sharply higher. The rapidly raising Dollar then induced Japanese institutions to dump their yens at hand for dollars, and the frenzy rally of Dollar had started. By 1998 Dollar rose to over 150 Yen/Dollar, near 100 % appreciation from the bottom of 80 Yen/Dollar at mid 1995. This Dollar rally started to affect US trade deficit in 1997, and had pushed the ratio of trade deficit to GDP up to 4.5 % by 2000. The over valued Dollar set off a chain reaction of economic crises among the countries that had pegged their currencies to Dollar. First was the Asian economic crises, then the reaction reached Russia in 1998, causing a large hedge fund to go under, almost dragging down the whole global financial system with it. Thus Dollar started to tumble in 1998. The Dollar tumbled again in mid 1999 when the chain reaction reached Latin America. This tumble of Dollar slowed down the expansion of US trade deficit, brought on the burst of US stock market bubble, and US real GDP started to stagnate in late 2000. The counter-clockwise loop in the correlation graph from 2000 to 2002 illustrates this 2000-2002 economic slowdown.
The shape of the 2000-2002 counter-clockwise loop is distinct from its two earlier cousins, the massive 1990-1993 loop and the smaller 1994-1996 loop. The recent loop is lying near 30-degree angle whereas the earlier ones are vertically erect. The inclined shape of the 2000-2002 loop reflects the devastated stage of US manufacturing industry. At early 1980's when the globalization gathered the momentum, US consumer goods import was twice of consumer goods export. By 2000 consumer goods import had reached three times of the export. The ratio of import to export of autos and auto parts had reached three times in 2000, compared to 1.5 times in early 1980's. In early 1980's US capital goods export was twice of the import, but by 2000 the hefty trade surplus in capital goods had all melted away. Furthermore, the capital goods industry became so globally integrated by 2000, imports and exports of that category have become synchronized; an imported capital goods item has a substantial exported parts in it, or vice versa, so export also falls when import stumbles. Under such a condition, the mere fall of Dollar from 150 Yen/Dollar to near 100 Yen/Dollar during the period of mid 1998 to the end of 1999 was not enough to lift US export in the stretch from mid 2000 to the end of 2001. Thus the growth of real GDP had continued to slump as the trade deficit retreated. Dollar had started to rebound in 2000. That dollar rebound induced expanding US trade deficit ratio again, and thus boosted real GDP growth rate from 2000, completing the inclined counter-clockwise loop in the correlation graph. The stagnation of the trade deficit ratio in 2003 accompanied by the rising real GDP growth rate was due to the dynamics of the economy shortly after coming out of a recession. Such a dynamic bounce was also evident after the massive recession of 1990. In that earlier case the dynamic period lasted for four years, from 1993 to 1997, but in the case of 2000-2001 recession the dynamic phase only lasted a little more than one year, another sign of the eroding health of US economy after a stretched period of running ever expanding trade deficit. Dollar had fallen anew vs. Yen in 2002, partly due to the renewed expansion of US trade deficit and partly due to the sharply lower Federal Fund's rate, reflecting the push of the panic button by FED to fight the economic slowdown that had started in late 2000. However, there has been a dramatic change in the landscape of international trade of USA. China has become the largest source of US trade deficit, but Chinese Yuan has been pegged to Dollar tightly. Thus the fall of Dollar vs. Yen from 2002 has failed to curb US trade deficit, and the trade deficit ratio has continued to expand briskly since 2004. This rapid expansion of US trade deficit is sustaining the strong real GDP growth rate until the third quarter of 2005, the most recent data used in this article.
4. Ill effects of a trade deficit dependent economy.
Various side effects are bound to appear for an economic entity that uses trade deficit to boost its consumption, an abnormal situation. It becomes important to monitor the US economy to catch such side effects in order to determine how long this kind of abnormal condition can last. The obvious place to look at this kind of side effects is the employment situation. As the globalization proceeds, jobs to generate goods and services will flow to developing countries, but the jobs to handle imported goods and the positions to recycle the trade deficit dollars will increase as import skyrockets. Off hand we cannot say that the expanding trade deficit will reduce the employment in USA. At the right non-farm payroll data are shown as black dots, dating back to year 1955. Quarterly averages of the payroll data are plotted in log-10 scale so that a stretch of straight line on the graph implies a period of constant rate of change of total number of jobs. To serve as a comparison, quarterly values of real GDP with price level of year 2000 set as 100%, called 2000-chained GDP, are plotted as red dots; the GDP data are also plotted in log-10 scale but vertically shifted down by an arbitrary amount to make the data fit into one graph. The log-10 scale of non-farm payroll data, expressed in the unit of million payrolls, are shown in the left scale and the log-10 scale of real GDP number, expressed in the unit of billion dollars, are shown at the right-hand side of the graph.
The real GDP data in the graph are rising roughly along a straight line, indicating that US real GDP has been rising with a constant rate of 3 to 4 % in average a year for a long time. The payroll data curve is flattening toward the right, indicating that the rate of job creation is steadily slowing. We may be tempted to say that the trouble in job market is stirring from these two observations. However, the decreasing rate of job creation alone cannot be considered as the proof of ill effect of expanding trade deficit conclusively. For example, a society with decreasing working age population but with steadily improving technology of producing goods and services will demonstrate a steady GDP growth rate but with a decreasing rate of job creation, though those are not the situation of USA today. We observe from the GDP and payroll curves that the topping of GDP and the peak of payroll numbers are well synchronized, with the peak in payroll number usually lagging behind by one quarter or so. The peaks before a fall in the payroll data are marked by black numerals, 1 to 7, and the tops of real GDP before an economic slowdown are labeled by red numerals from 1 to 7. For the economic slowdowns before the globalization period, that is, for the cases of 1 to 4, the time required for real GDP to recover to previous top and the time required for the payroll number to match the previous peak are more or less similar. However, as the globalization takes hold and US trade deficit has expanded, the situation becomes vastly different. In the economic slowdown marked by numbers 5, it took real GDP 7 quarters to surpass the previous top, and it took payroll number 9 quarters to get over the previous peak. In the economic downturn of 1990 marked by numbers 6, it took real GDP 5 quarters to recover, and took the payroll number 10 quarters to surpass the previous peak. In the economic downturn of 2000 to 2001 marked by numbers 7, real GDP recovered after 5 quarters, but it took payroll number 16 quarters to go over the previous peak! Since those recovery periods are the time of economic misery, it is safe to assume that drastic improvement of the technology of producing goods and services are not taking place during those recovery periods. The successive prolonging of the time duration for payroll number to recover compared to the time required for real GDP to recover in the age of globalization can be considered as the evidence of the weakening ability of US job market to create new jobs due to the increasing pressure of run away trade deficit. In the next full-blown economic recession we should expect that the payroll number will never fully return to its previous peak before the next economic recession arrives. Thus in long term US payroll number will gradually decrease, and the society gradually approaches the jobless society that is purely supported by trade deficit and the borrowing from foreigners as depicted in Article 7 titled "Globalization Utopia", posted on this website.
5. What is in store for US economy?
After studying the finer details of how the trade deficit is correlated to the real GDP growth, and pointing out the weakening job creation potential in US economy due to the relentless expansion of trade deficit, the natural question that will come up is how US economy will evolve in future. As has been pointed out in the USA Outlook Update (January 21, 2006), US economy probably will experience a short and minor economic slowdown if there is no serious flaring up of Iran's nuclear research crisis. If that is the case, a small counter-clockwise loop as that of 1995 will develop to mark the slowdown and the shape of that small loop will be interesting to watch. However, if Iranian crisis worsens, a mild slowdown may turn into a full-scale global recession. If look beyond the short-term horizon, we will see that the world is already trapped in the globalization scheme; US cannot stop expanding its trade deficit and Pacific rim countries cannot change their economic structures to afford the reduction of exports. Thus the train of more and more cross Pacific Ocean trade imbalance will continue to run to whatever its destination is, a total ruin or a utopia for US. Economic recessions are bound to happen every decade or so. US economy will see more job loss and less job creation in successive recession-recovery cycles, until the utopia of jobless society of Article 7 is achieved, unless either USA or Pacific rim countries consciously pull the plug and ruin the whole globalization scheme.