Back in the days before my economic enlightenment I used to wonder what all the fuss was about every month when the balance of trade numbers came out. What did it matter if we spent more for the oil and cars and VCR's we bought from foreigners than we received back for the airplanes, computer chips and wheat we sold to them? Then I found out about how the trade deficit impacts the Gross Domestic Product (GDP)---the penultimate measure of the state of the U.S. economy.

The GDP can be defined rather simply and elegantly by the following equation:

GDP = C + I + (X - M) + G

where C = Consumption, I = Investment, X = Exports, M = Imports, and G = Government Spending.

In subsequent articles I'll talk about how all the stuff I've been writing about for the past several weeks relates to this equation. But, for today, let's concentrate on the (X - M) part of the equation. Notice that all of the terms in the equation except the M [Imports] term are additive. They all contribute in a positive way to the GDP. But, alas, the dreaded M term is a subtractive term. It has a negative effect on GDP.

Now, more and more, as individuals and businesses and denizens of cyberspace, we are all becoming citizens of the world. So, there's no stopping it, the U.S. is going to become more and more involved in international commerce. If we could just manage to sell more goods and services overseas than we bought there, then X would be greater than M in the equation above and the net effect of all this international trade would be to enhance our economy as represented by the Gross Domestic Product.

But, sad to say, this is not the way things are. In fact they haven't been that way since OPEC began to flex its muscles on oil prices back in the mid 1970's. Since then the inflation adjusted U.S. trade balance has been negative. Sometimes more negative and sometimes less negative, but---nonetheless---negative.

What's been happening lately? Well, just this morning the Bureau of the Census and the Bureau of Economic Analysis, through the Department of Commerce, announced that during August total exports were $65.7 billion and total imports were $74.5 billion. Thus, the goods and services deficit for August was $8.8 billion. This was $2.4 billion less than the revised figure for July of $11.2 billion. In fact, the August deficit was the lowest monthly number since last December. But, we shouldn't take too much encouragement from the data for a single month. For the January-August period this year the deficit increased at an annualized rate of $123.2 billion. This compares with deficits of $106.2 billion in 1994, $74.8 billion in 1993, and $39.5 billion in 1992. In recent years the trade deficit just seems to be getting bigger and bigger.

To gain further perspective, let's see what percentage impact these deficits have on the final annual figures for GDP. Based on data available for 1995 thus far, the annualized inflation adjusted deficit will be 2.28% of GDP. Similarly, the trade deficit was 2.0% of GDP in 1994, 1.42% in 1993, and 0.64% in 1992. Now, when we consider that the net annualized changes in the GDP during the first and second quarters of 1995 were only +2.7% and +1.3%, we realize that the current estimate of the negative impact of the trade deficit is approximately the same size as the entire positive change in the GDP.

Let's hope that the Fed, in maneuvering toward a soft landing for the economy, has made allowances for the significant wind shear embodied in the relentlessly expanding trade deficit.

Now I know what all the fuss was about.

Byline: Lafferty (MF Merlin)