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Trade deficit, new home tax credit and easy Fed policies threaten double dip recession

By Peter Morici
web posted December 14, 2009

The trade deficit, new home buyer tax credits and Federal Reserve support for the mortgage market threaten a double dip recession.

More than anything, U.S. businesses need customers -- people buying American-made goods and services -- to hire workers and continue the economic recovery.

Money spent on imports of Middle East oil or Chinese coffee makers cannot be spent on American products unless those dollars return to purchase U.S. exports.

Thursday, the Commerce Department will report that imports of goods and services exceeded exports in October by about $35 billion -- a $420 billion annual pace.

The trade gap subtracts more from the demand for U.S.-made goods and services than President Obama’s stimulus package adds. Moreover, Obama’s stimulus is temporary, whereas the trade deficit is permanent.

Petroleum and Chinese manufactures account for nearly the entire U.S. trade imbalance, and the cost of those imports will increase as oil prices rise and consumer spending recovers in 2010.

When imports substantially exceed exports, Americans must consume much more than the incomes they earn producing goods and services, or the demand for what they make is less than the supply, inventories pile up, layoffs result, and the economy goes into recession.

From 2004 to 2008, the trade deficit exceeded five percent of GDP, and Americans borrowed from China, Middle East oil exporters and others to consume more than they produced and keep the economy going.

Americans posted as collateral overvalued homes financed on shaky mortgages. When mortgages and banks failed, home prices and retail sales tanked, and the economy was thrust into the worst recession in 70 years.

Now huge stimulus spending is required to resuscitate demand and jump start business activity. However, as the economy recovers, the trade deficit on oil and purchases from China will grow, further taxing demand for U.S. goods and services. Once the stimulus money is spent, the demand for U.S.-made products will fall again, and the economy will risk falling retail sales, more layoffs and a second, much-deeper recession.

President Obama ignores fundamental causes of a rising trade deficit -- China’s subsidies for domestic oil consumption, which drive up the price of U.S. oil imports, and China’s purposeful manipulation of currency markets to maintain an undervalued yuan and subsidize its exports into U.S. markets.

President Obama’s policies to fight the recession are delivering only a moderate lift to the economy. As U.S. payments for imported oil and Chinese consumer goods rise and stimulus spending runs out, the escalating trade deficit will push the economy down again, threatening the feared double-dip recession.

Unemployment could rocket to 15 percent.

Meanwhile, federal efforts to support the housing market are creating another glut of unsold homes and perhaps a second, menacing bubble in the housing market.

During the recent economic expansion, Americans built and bought too many homes, and now the market is oversupplied.

Tax credits for new home buyers give builders a temporary reprieve from an adjustment period of slow demand, as population and economic growth work off the surplus of housing, but those policies put off an inevitable period of slack new home construction and falling land values.

Similarly, by purchasing mortgage backed securities, the Federal Reserve has pushed borrowing rates to historic lows. Since May, home buyers have used this windfall to bid up prices for existing homes.

When the tax credits and Federal Reserve subsidies are withdrawn as planned in 2010, home prices could plummet again, and a downdraft in consumer spending and residential construction could result.

Together, the trade deficit, reckless tax subsidies for home builders and excessive liquidity provided by the Federal Reserve threaten a second dip in GDP and depression era unemployment. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.

 

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