Trade Worsens; Realism at the Fed

A mixed bag today: the US trade gap widened, despite a good increase in exports; and Sandra Pianalto, the head of the Cleveland Fed, made a very sensible speech in which she talked down inflation expectations, and gave a quite gloomy view of the job market.

The trade gap widened to a nine month high of $48.2 billion in March, that’s up slightly from the $45.4 billion in February. Exports were strong, particularly industrial supplies and agricultural products, with the total increasing by 4.6%. One negative was a decline in aircraft exports, but that sector is notoriously chunky and hard to predict on a month to month basis. Obviously the cheaper dollar had some effect in driving this increase, and that, coupled with the worldwide pick up in growth will help lift exports more during the rest of the year.

On the downside, imports grew even more quickly, by 4.9%, largely because both food and oil imports surged. The US imports of oil grew from 8.7 million barrels per day to 9.5 million, even though the average price of oil also rose by $6.59 to $93.76 per barrel. America simply seems unable to shake its oil addiction even at these prices. This increase in oil price is mainly due to the turmoil in the Middle East – when isn’t there turmoil? – and is a driving force behind the recent rise in headline consumer inflation. Likewise US imports of foodstuff grew not just in terms of volumes, but also in terms of prices, so imports were hit with a double whammy which looks set to continue for some time to come.

Meanwhile, the bilateral trade account with China worsened to $18.1 billion, which is an ironic coda to the trade negotiations just wrapping up between the two countries. Note, though, that the overall Chinese trade surplus was less than that in April, at $14.1 billion, which suggests that their trade gap with other nations is in deficit. In general, trade has picked up globally – US trade with central and south America hit all time highs in March, as did US exports to Canada, while US trade with Europe is now back to 2008 levels.

Worldwide activity is evidently well on the road to recovery.

The surge in oil and food prices has led some to fear a consequent surge in US inflation. There is no evidence of this. Wages are the prime factor driving long term inflation, whereas items like food and oil tend to bounce up and down sharply with much less overall impact. There is no question that commodity prices will rise as a long term trend – demand will drive that increase as long as supply remains less flexible – but that impact will be mitigated by a shifting mix in consumption, and stagnant wages.

This is the basic argument Sandra Pianalto gave in her speech today in order to explain why she, and others at the Fed are not concerned about inflation. The recent spike in headline inflation is being driven by what appear to be temporary supply problems – that Middle Eastern turmoil – rather than a sectoral shift. And with the wage and employment outlook looking decidedly weak, there is no solid case for raising rates to dampen inflation fears. Monetary policy must be based on the medium to longer term outlook not the short term which is always more erratic.

This is all rather dull. But at least it is a clear articulation of a realistic view of things, which in sharp contrast with the near hysteria of the hawks who see ghosts in every consumer price increase number.

What does this mean?

The trade figures are worse than expected, but not so much worse that they will distort the GDP figures released last week. First quarter GDP growth of 1.8%, at annual rates, looks like it will stand unchanged, at least as far as trade is concerned. And with Pianalto suggesting it could take as long as five years to get the job market back to normal, there is no impetus behind a rate increase.

So, steady as she goes. GDP growth of between 2.0% and 3.0% is still the general forecast, with a little more risk on the downside than on the upside. And weak employment. We are very close, in other words, to the dreaded doldrums of stagnation. This is not unusual for a recovery coming out of a downturn caused by a collapse in banking. History suggests stagnation or a slow recovery is the norm after a finance driven debacle.

Quite why our policy makers didn’t take history into account in their decision making is another question. Presumably they believe stagnation is acceptable. I don’t. Oh well.