The Euro -- Breaking Up is Hard to Do

Many of the international monetary experts are weighing in on the future of the euro.  While I might not be an international monetary expert I do need weighing, so here goes. There is little reason for the euro to implode, for Spain to leave the euro, or for there to be separate clubs for euro-weak and euro-strong countries. While the euro might weaken more in the near future I think it will remain the currency of at least 16 countries for the foreseeable future. I agree with Neil Sedaka's 1962 tune from the good old days -- Breaking Up Is Hard To Do. 

Notice that when a hurricane devastated much of Louisiana, that state was not kicked out of the dollar alliance of 50 states plus others. That was true even though it might have helped folks in New Orleans if they had their own currency and it depreciated a bunch. Just think of all the Japanese tourists with their Nikons who might have been able to afford a neat trip to Patty Obrien’s, including a swamp boat ride and all the ‘Gator-filled Po-Boys they could suck down. Of course, let’s not forget a midnight beignet at the Café Du Monde.  But I digress.

You might retort that Louisiana is part of country called the USA and Greece, Ireland, Spain, and Portugal are part of a monetary union called the Eurozone. To be part of this monetary union all 16 members of the Eurozone signed a treaty in Maastricht that is a very formal document with pretty lettering and no smiley faces. I agree that it doesn’t have the force of statehood but it clearly is not trivial – and was not entered into lightly. All members of the Treaty drank copious amounts of Belgian coffee with delicious French pastries over many years and I am guessing that on more than one occasion a German official pointed out after one-too-many Schnapps that all members were not created equal.  Clearly they spoke of contingencies and escape mechanisms.

But even if they didn’t and some of what has transpired in the way of country debts and economic contractions was not expected, there is still little reason to break up the Eurozone. At least until recently there was a line-up of countries that wanted into this elite club – and for good reason. The Eurozone did what it was expected to do – it removed a major irritant from international trade between a growing number of European countries whose economies were becoming much for economically integrated. I am among millions of travelers who remember how stupid and irritating it seemed, when traveling around Europe, to have separate little piles of lira, pesetas, deutsche marks, etc. To businesses, this inconvenience was multiplied into unnecessary transactions costs. Of course, when these European currencies were sometimes changing in uncertain ways this really hurt business planning and it made a lot of sense to eliminate that risk by adopting one common currency. Wow! How cool can you get! As there is still much integration to unfold in Europe, these benefits will continue to hold and grow.

There is much more to the benefits of the euro – and countries like Greece, Ireland, Spain and Portugal reaped some of them more than others. Clearly from the standpoint of currency credibility these four and some of the other members gained when they gave up currencies with bad reputations for one that seemed a much better bet for the future.

Still you might say, wouldn’t the weaker countries benefit if they could depreciate their own currencies? And the answer is probably not.  All countries have policies tools to help when things go wrong – monetary, fiscal, immigration, financial regulation, and many more. While it is true that exchange rate management can be a powerful tool for a country, there are many countries that never use it. Many prefer to peg to the dollar or some other currency or bundles of currencies. Many simply do not believe it is wise to try to fine-tune their economy with the exchange rate.  So it is not a universally accepted best-policy. Whatever could be accomplished by depreciating their currencies in the current crisis could be managed with other traditional policies.

And one could argue that such exchange rate management policies or dirty floats come with great risk. There are numerous recent historical examples where speculators or hedge funds have caused devastating impacts on countries that waited to use depreciation as a tool of macroeconomic or trade policy. Right now the euro is taking a little beating from the markets – but certainly nothing like non-Eurozone countries have experienced in the last couple of years. I doubt that Ireland, Spain or Portugal would be better off with their own currencies depreciating by the likes of 50% right now!

And then there is the case of the strong countries, like Germany. Why not boot the scofflaws? Why should German citizens bear part of the brunt of weaknesses in neighboring countries? For one thing, Germany, France or the other stronger countries cannot really escape the fate of their weaker trading partners because of interdependencies. While the euro might be stronger today with a smaller club, contagion would still impact a wider group of countries whose economies are linked. Clearly the banks of the stronger countries hold the liabilities of the weaker ones. Business firms engage in cross-border trades in myriad ways. If Spain, for example, applies a fiscal remedy that slows economic growth in that country, clearly with or without the exchange rate impacts, this slower growth will spill over into its European trading partners. This is the price one pays for economic integration. If you want to receive the benefits of the relationships then you sometimes have to suffer through the costs – whether they come through exchange rate effects or not.  Furthermore, just because weaker countries might be asked to leave the Eurozone, they would still be members of the European Union. The EU might, in that case, be involved with policies to bailout or otherwise assist the weaker members.

In short, the benefits of the euro continue and neither the weaker nor the stronger countries will be better off by reducing the number of countries participating in the Eurozone. The best bet is that the Europeans will do what they often do – eat more croissants with that wonderful Spanish ham and debate until well into the night over cognac and brandy. The EU started a long time ago. The Eurozone is newer but has already endured much. In all, European countries show an ability and readiness to hash it all out and move forward. I bet they will continue to do the same now.  Don’t look for any pesetas anytime soon. 

Blinder makes Monetary Policy on the Moon

I eased off the topic of Quantitative Easing (QE) until now because there was so much being written about it. But then all this stuff about Prince William and Princess Kate hit the news and I realized two things. First, I am getting really old. Wasn’t Prince William playing in his crib last year? Second, you people need a little diversion from the Royal Family. And then to top things off Alan Blinder, a former Fed vice chairman, called QE2 a “garden variety monetary policy.”

Wow. Professor Blinder must be growing his artichokes on the moon if he calls QE2 garden variety. It is true that the Fed always does monetary policy by buying government bonds and by trying to influence interest rates. The buying of the government bonds washes the banks with new increased liquidity and reduces the pressure on the cost of bank borrowing. The general idea is that if the cost of bank funds decreases then banks will be willing to reduce interest rates on loans. The story continues – and then goldilocks lived happily ever after. Err, I mean the story goes that firms see lower interest rates and they jump in their Fords and drive down to the carry out window and borrow tons of money and spend it on new machines and workers. 

While I make a little fun with the story, the truth is that this sometimes works. The truth also contains the fact that most of the Fed's buying of government bonds is in bonds of short maturities. Therefore most of the direct impacts on interest rates occur at the short end of the term structure – on bonds that mature in two years or less. Of course, they hope that the reduction in short-term rates would bring about a decline in longer- term rates as well. To have the full or complete impact the story wants to have all rates decline. 

The above is garden variety monetary policy on planet Earth.

So what is different about QE2? First, it was invented in places like Japan and now the US where short-term interest rates are virtually zero so that the above story is no longer relevant. The Fed cannot reduce short-term interest rates and the cost of bank funds. So they decided that if they are going to make Mad Money (the TV show) on a regular basis they better come up with something cool and novel. If Nancy Pelosi cannot save the US economy, then maybe the Fed can.

Second, the Fed realized that even though they were able to drive short-term interest rates to zero (ta da!) rates on longer term assets were not coming down as much or as fast as they wanted. After all, to have the largest impact on spending it is important to impact loans with longer maturities. So QE is different – since it worries less about short-term rates and forcing even larger amounts of unused reserves on banks – and more on directly influencing long-term interest rates. While this has been tried by the Fed in the distant past, it is NOT DOING MONETARY POLICY AS USUAL.  And, of course, you wouldn’t have thousands of articles being written about QE if it were business as usual. 

Policy conservatives have plenty to chew on. QE and QE2 represent a broadening of the Fed’s tools or perhaps even its mandates. If policy conservatives want the Fed to focus its energies more narrowly (aiming only at inflation), then they are not going to sit around smelling incense as the Fed gets more active.  Moreover, policy conservatives might point out that QE1 already stuffed plenty of money into pillows and adding a second round is only asking for trouble. Professor Blinder can show you overhead slides of how easily it is to pull money back out of those pillows when necessary but what he can’t easily show you is how difficult that plan is to put in place in the real world right here on Earth.

Third, the difference in QE2 also relates to the business environment. Keynes convinced most of us that monetary policy is NOT the best tool to use when the recession is deep and when confidence is failing. Keynes and his legion of legally-obtained medical marijuana smokers have a preference for fiscal policy. Read recent articles by Krugman and Stiglitz to see why some activists prefer fiscal to monetary policy today. While you should not count QE2 out until the bell rings, it does not surprise me that most long-term interest rates rose – did not fall – once the Fed got serious about some of the details of QE2. As Keynes might say today, the Fed‘s flailing attempt to do something is doing nothing but creating a higher risk environment. Alan Blinder and some current Fed officials can say all they want – but markets are smarter than that. QE2 is not a good policy for the Earth at this time.

Voodoo Economics, Part 2

In my last post – Voodoo economics – I hit my page limit before I got to any real specifics. I laid out a rationale for why demand-side policy probably was largely spent and gave some background on supply-side policy. The main point is that supply-side policy has a checkered reputation that is mostly undeserved. It is pretty easy to dispense with the charges that it won’t work or that it is trickery. The more difficult aspect is that supply-side policy generally works BECAUSE IT STARTS by impacting rich folks and business firms.  But what matters most is where it ENDS – so let me get on with that point.

If you are imbued with equity and making sure that all people are always treated equally then you may find supply-side policy offensive. If you HATE capitalism and think that most capitalist policies are part of a great hoax that perpetuates current power and wealth, then you are probably not going to trust supply-side policy. If you are simply hoping to find a policy that will help us permanently exit this horrible recession and slow growth period, then you will want some assurance that any policy will do what it is supposed to do – create more economic prosperity and jobs. So where is the beef (or tofu for my vegetarian friends)?

Keep in mind that every policy is uncertain and risky. The Fed’s new quantitative easing policy is hotly debated. Another round of short-run government stimulus is no slam dunk and has its supporters and detractors. Supply-side policies are no different so let’s not read what I say here as blue-sky advocacy.  In my previous post I made the point that supply-side policy works because it directly impacts those who do the hiring and produce the output. The supply-side policy is directly aimed at business firms’ bottom lines. The basic intuition is that if policy can somehow make business executives more optimistic about their future revenues and costs, then they will be more willing to make capital investments and hire more workers.

Of course, like all policies, supply-side policy has its own moral hazards and unintended consequences. So we shouldn’t throw the baby out with the dirty bath water. Whatever advantages are given to companies and high income investors, attention must be paid to how they will translate into jobs and economic growth. I have said many times that I am neither a democrat nor a republican. Adam Smith was very clear that while he favored letting the invisible hand work, that firms are just as capable of corruption and waste as governments. While supply-side immediate impacts must be directed to firms and higher income investors – the true value of this approach is in its ultimate impacts in terms of higher output, more employment, and higher incomes.

What I didn’t do in the last post is to discuss the many ways this can be done. Notice that even among supply-siders there can be very different preferences for specific policies. Much depends on what you think is the biggest problem – what is making firms less willing to use their piles of cash today? What is making them less willing to make capital investments? Why don’t they hire more workers?

For starters, imagine one group of supply-siders who believe the economy is on the mend. They believe that we got hit by an economic firestorm that rocked our economic foundations but that the resilience of the economy provided the foundation for recovery and the policies of the last two years did not prevent some early healing. These supply-siders point to various green shoots or data that show promise of a continued recovery. Their supply-side recommendation might be – Don’t rock the boat! They might advise the government to create as little change as possible.  Just let the economy continue to heal. Firms will jump in as soon as they are surer that this recovery really has legs.

Of course, another group of supply-siders might believe that government policy was too aggressive and that we have created a very risky business environment typified by too much government debt. We all have seen some really worrisome estimates of future debt burdens. They bring up scenarios in which the US becomes the disdain of world investors causing a plummeting dollar, declining stock prices, and rapidly rising interest rates. It is not a pretty picture. These supply-siders believe that you can reduce the risky environment by paying attention to imbalances in the balance sheet of the Fed and the large liabilities of the government. Firms will not hire workers in sufficient numbers until they believe government debt and Fed policy are under control. Their supply-side policy means significant changes in the government budget and Fed policy.

Other supply-siders worry about international competitiveness. They worry about a government that seems to give lip service to free trade and a strong currency but whose real actions seem to put off the real decisions about trade or they lead to a declining value of the dollar. Whether it was the recent Asian Summit or the G20 meetings, the US was able to accomplish little. We have stalled so long on bilateral free trade agreements that our potential partners now seem to be the ones dragging their feet. The US harps on about China’s currency when most people agree that the US is equally culpable. Geithner blames the recent spectacular declines in the dollar on a reversal of safe monies. But what does he think caused the “new” view that the US is an unsafe place to invest? Keep in mind that while dollar declines might help exporters – they do very little to improve the competitiveness of US importers and they accelerate the desire of foreign investors to move their money out of the US. If you were a foreign investor, would you really want to receive your future return in dollars that are worth 15% less?  Real free trade and a real strong dollar are not easy to buy today. But they are an indispensible part of a strong and viable supply sector. 

Most discussions of trade end up with a story about saving. We all know by now that the US saves too little – and therefore our imports end up rising faster than our exports. This implies a need to borrow from the rest of the world – and we do. It is pretty clear that we in the US need to save more and our trading partners could save a little less. But who does saving in the US? Short answer – rich people and companies! The only real way to increase saving in amounts that matter is to increase the reward to saving. A Fed policy aimed at zero interest rates does nothing to help! A threatened increase in income tax rates and capital gains tax rates does nothing but reduce the incentive to save. Opponents of lowering these rates always point to the disproportionate benefits that would go to rich people. But notice that their focus is on the immediate impacts. Instead they should trust that a country with normal or strong saving more easily channels resources for innovation and labor productivity without having to borrow from abroad. Saving is the key to economic growth and rising incomes.  The ultimate effect is the one we should be focusing on today.  Thus some supply-siders advocate lower tax rates for companies and households regardless of income.

I am getting too wordy again and I have only discussed four examples of supply-side policies. I don’t want to promise a Voodoo 3. There are so many other great topics to be talking about!

So let me just summarize the rest briefly. Another approach to supply-side policy focuses on the reward to produce and the reward to work. While the US used to have a reputation of a country with a small government and low taxes, this is no longer the case.  Whether it is taxes on energy or regulations that require firms to guarantee health care or be greener it is no secret that firms feel increasingly burdened by government. Given the inertia of the government, firms are also increasingly uncertain as to how these new regulations and taxes will impact their future net revenues.  Add to that a worry that current unflattering attitudes toward the rich and corporations raise expectations about higher taxes on the incomes of companies and high income individuals. A supply-side approach recognizes how counterproductive this environment is to economic growth and employment.

Several leaders of the Democratic Party have very recently pointed out that postponing increased tax rates for the rich is the fair thing to do. They also are holding social security out of any discussions of how to solve long-term government debt challenges. Again, the issue is fairness. But what does fairness mean? I really doubt that dragging our feet on needed policies for economic growth is going to have an impact on the rich or the poor. The rich will take care of themselves at the country’s peril. The problem of poverty has little to do with marginal tax rate changes and everything to do with very long-term factors involving sociology, education, and training.  All government policies should not be held hostage to fairness. The fair thing to do is to take a very comprehensive and realistic view of poverty in the US – and then do something about it. 

Supply-side policies deserve a good look. There are many ways to skin this cat. But we won’t get to the first step if we can’t get beyond the Voodoo. 

Voodoo Economics, A Trojan Horse, and Trickle Down: Is it time to give the supply-side a try?

In Econ 101 we learn that economics is all about supply and demand. I was recently in South Korea where flooding caused by a typhoon virtually destroyed the cabbage crop. While Bugs Bunny would be quite upset about such an event it was even more important and upsetting for Koreans whose main dish, kimchi, is largely composed of cabbage. Kimchi is eaten at least once a day by many Koreans. Most Koreans have two refrigerators – one for all their other food and the other just for kimchi. I do not hide the fact that I love kimchi as much or more than most Koreans and I have several shirt stains to prove my devotion to the wonderful dish.

It was no surprise to anyone when the price of kimchi rose by 600% this summer. Why? Because of supply and demand. While the demand for kimchi had remained largely unchanged by the typhoon the supply had been reduced by the bucket-full.  As such grocery stores and restaurants bid up the price of this very scarce commodity as they tried to fulfill the usual wants of their customers. The market result was a much higher price. As kimchi came into Korea from abroad and the supply began to recover, the price of kimchi peaked and then started downward.

As the US Congress reconvenes as lame ducks and then for real in 2011, we should remember that government has policy tools that can be aimed directly at demand, supply, or both. But as the title of this message suggests, any member of the US government who recommends a supply-side policy will have to get over huge political obstacles. When George Bush Sr. was competing with Ronald Reagan to get the Republican presidential nomination in 1980, he labeled Reagan’s policy Voodoo Economics. The implication was that Reagan was trying to foist magic on the American public. Supply-side economics was also referred to as a Trojan Horse implying this policy was a trick on the American people. Finally, supply-side economics is alleged to be a tool to help the rich at the expense of the poor – meaning that the real benefits go to rich people and companies and all we can do is hope for some benefits to trickle down to the poor and middle class.

In short – supply-side policies are thought to be magic, a cheap trick, and a tool to steal from the poor and give to the rich. That’s hardly a resounding vote of confidence. It is no wonder politicians do not want to stand up and be counted for a supply-side approach. But I will argue below that the supply-side reputation is better than the title suggests and supply-side policy is just about perfect for our challenges today.

Let’s begin by quickly defining the supply-side. Economics concludes that while society will want and express a demand for food, autos, appliances and multi-colored condoms, it takes business firms to produce them. When we study demand we focus on the factors that determine what households want to purchase. But when we analyze supply, we emphasize the ability and motivations of business firms to produce those products. Supply does not get created magically. Firms must put together resources – like raw materials, intermediate assemblies, labor, machines, factories, and energy – if they are to bring the right goods to market at a competitive price.

If President Obama wants to improve the climate for production and employment, then he has choices. A demand-side approach focuses on the consuming household.  He can recommend tax reductions and subsidies to induce households to spend. He can use government legislation to direct the government’s awesome machinery to spend more. When we talk about a “stimulus package” we are usually thinking about how the government can create more demand in the economy. Despite all the controversy right now, it is true to say that sometimes these demand-side remedies work. The government stimulates demand and firms respond like Pavlov’s famous dog – demand increases and firms produce more. To produce more they often hire more workers.

But right now at the end of 2010, it isn’t perfectly clear if the demand stimulus choice is the best one. We saw what happened when cash for clunkers expired. In a previous post I explained that households are repaying debt or are otherwise saving. Given the remaining uncertainty about the economic recovery it seems wiser for them to be saving and not spending. Of course, business firms are watching all this and are not about to risk their capital to produce more until they are more certain that any demand increases are going to have some staying power.  That leaves the government’s direct spending on the economy. But even here we learned how disingenuous Congress can be. So called shovel-ready projects were about as ready as a Medicare patient at a high-jump competition. Government largess was aimed at a multitude of Democratic pet peeves. We learned that the political process can be very slow and unreliable when it comes to quickly generating more demand for goods and services. Yet it was perfect at increasing government debt.

The second choice available to President Obama is a supply-side policy. Supply-side economics was boosted when Jean-Baptiste Say ( Say’s Law) declared that “supply creates its own demand”.  The general meaning of this statement is that factors which cause permanent changes in society’s capacity to produce often lead to conditions (e.g. falling prices) which raise the level of demand to the higher amount of supply. Most economists today use Say’s Law to guide their analyses and forecasts of long-run economic growth. These forecasts have no role for demand and totally explain long-run changes in economic growth with two factors: labor supply and productivity growth.  The upshot of economic growth theory is that strong growth will occur only if and when labor supply and labor productivity growth permits it. Persistent economic growth is the only way to have persistent and permanent increases in employment.

Today our demographics indicate there is very little potential to increase economic growth and employment through faster labor supply growth. Our baby boomers (hurrah) are retiring and there is only so much that can be done through immigration or inducements to remain in the labor force.  So that leaves labor productivity as the only real route to stronger economic growth and employment.  How does a government formulate policy to achieve stronger labor productivity growth? First, the government needs to recognize that innovation and higher productivity are the keys to business success – firms with higher productivity compete better. So the firms are willing partners in any policy that improves labor productivity.  Second, the government must realize that productivity enhancements are expensive and often require firms raising large amounts of capital. Third, firms will not take these large risks without believing that they will pay off – and create excellent returns to the owners and stockholders. Fourth, these payoffs relate very much to two key factors in the business environment – expected future revenues and costs.

In a nutshell – supply-side policy needs to create optimism and clarity among business firms about future profits. This optimism is necessary for the capital investments that will lead to higher economic growth and employment. Any policies that promise restrained business costs and more certain long-run revenues and after-tax profits are what we need right now. These policies are what we call supply-side policies.

Is this magic? Ask China and the dozens of other countries that have implemented similar supply-side policies if they have worked.

Is this a trick? The above discussion explains why the supply-side approach should work.  While this approach might not work, it clearly has a strong rationale for why it should be effective. This is no Trojan Horse.

Is this trickle-down? It is no act of deception to recognize that supply-side policy generally aims its most immediate impacts on business firms and wealthier people.  How much of the benefits are absorbed by the poor or the middle class is definitely a legitimate question. My reading of economic history is that the only real way to permanently raise the standard of living in a country is through long-term economic growth.  Schemes to redistribute income or to equalize incomes can be effective only in an environment of growth. 

Demand-side policy is very risky right now. It might not work. Worse yet, it might create higher uncertainty about the long-run future of America as it raises US debt, worries our trading partners, and opens up concern about when and by how much the future stimulus will be withdrawn.  It is time to give supply-side policy another look.

There is a lot more to say about this issue. Hopefully this is a start to a good discussion. Let me know what you think.

Misunderstanding Changes in US Competitiveness -- Miss Piggy and US Imports

Recent government releases of trade data have Americans concerned. The monthly trade deficit increase in July and was approximately $10 billion higher than in July of 2009. It got even larger in August and September 2010. The National Income and Products Accounts definition of the goods and services trade deficit found the deficit had increased to an annualized  -$515 billion in the third quarter of 2010 -- $124 billion larger than it was in the third quarter of 2009. (Data are real, annualized) 

The data speaks for itself but the press and politicians have generated only misinterpretation and confusion.  As usual – they are more concerned about winning friends and votes than they are about faithful interpretation.  A worsened trade deficit is nothing to be happy about – but there is much more to this picture. The graph below has annualized quarterly real net exports of goods and services (annualized exports of goods and services minus annualized imports of goods and services) for all quarters between 1995 and the third quarter of 2010. The most noticeable aspects of the graph are the deterioration of net exports between 1995 and 2005 and the subsequence reversal in trend starting in late 2006. The eyeball easily sees that NET EXPORTS ARE IMPROVING.  

 http://research.stlouisfed.org/fred2/graph/?id=NETEXC       

While it is true that there was a deterioration in a few quarters since late 2006, the overwhelming story is the improvement. But as I will explain below, the recent improvement in net exports has very little to do with US trade competitiveness and should not be interpreted as a return to normal. It has more to do with large and erratic quarterly swings in our appetite for foreign goods. Inasmuch, there is little that policymakers can or should react to from these recent quarterly changes. Clearly, the one-quarter data does not suggest a need to cajole China or anyone else.

While it is true that the one-quarter change of -$106 billion in 2010 QII looks large, it does not necessarily bode ill. We have to wait and see. In fact, a closer look at the quarterly net export changes reveals a very large increase in quarterly variability since 2006 – the standard deviation was approximately $50 billion per quarter. That means that the large one-quarter change of - $111 billion in 2010 QII was within 2 standard deviations of the mean change since 2006 of $17 billion.  This means that $111 billion falls within the 95% confidence interval and therefore is not an unlikely outcome.  With this kind of volatility it would not be surprising to see net exports improve by $111 billion in 2010 QIV.

A second issue is the erroneous interpretation. When we read that net exports are deteriorating we question the ability of US firms to compete globally. While net export changes are the result of changes in both exports AND imports – we often focus only on the export side. The misleading interpretation is the conclusion that if net exports are worsening, then it must be because US firms cannot compete anymore. Or perhaps it means that China is an unfair trader – slapping egregious import tariffs on our goods or manipulating its currency. Clearly there must be some unfair practices in China and abroad or our US companies would do better. If we are having trouble selling goods abroad, the story goes, then this is hurting our recovery from the recession and is having a negative impact on workers who produce exports. Let’s face it – it’s a chilling story and it gives our politicians a way to ride in on their silvery steeds and save the day against those unfair and mean enemies.

Of course, none of this is true insofar as recent events are concerned.  US exports increased by $225 billion in the last five quarters – an increase of more than 15% in real terms. Exports increased in every one of those five quarters and by amounts ranging from $20 to $84 billion per quarter.  If anything – it has been these increases in exports that have sustained the US economy and prevented job growth from being even worse!

It turns out, however, of you want to talk about US Net Exports for the entire time period and the key sub-periods – the trade story is about IMPORTS not exports. The below chart – if it is readable on the blog – shows the quarterly changes in exports (blue diamond) and imports (red squares) since 1995. 

http://research.stlouisfed.org/fred2/graph/?id=EXPGSC1,IMPGSC1,#

Here’s is what we should notice –

First, in the vast majority of quarters from 1995 to 2005 – the imports are above the exports – meaning that no matter how much exports increased in a particular quarter – imports increased by more. We can really suck in foreign goods!

Second, in the time period directly afterward 2005 – the changes in imports declined and then went negative. As the recession approached and worsened and US incomes decreased – we quit spending. We stopped buying all goods – both domestically produced and imported.  Export changes also shriveled but by less than the imports. So net exports improved! So for a while we see net exports improving not so much because US firms were more competitive in global markets – but because the US was hurting and our populations was buying less.

Third, in the final five quarters – 2009 QIII to 2010 QIII – we see the US economy starting to recover and our appetite for goods returning. Despite the large and positive swing in exports – imports started rising even more and the trade deficit worsened in 2010.

Fourth – looking at the chart you see that these recent changes in imports are probably unsustainable – since they are well out of line with the past history of import changes. The export recovery seems much more sustainable.

In summary, recent changes in net exports tell us less about changing competitiveness of US firms and more about the appetites of US consumers and firms.  Increased volatility of net exports warns us not to make too much of one-quarter changes of the recent past and coming future. If we want to restore the US to balanced trade, the data suggests we should think more about how and why US households and firms increasingly look abroad for their purchases.  If foreigners are so willing to buy US goods – why aren’t we? Pointing the finger at China might not be so smart. Our world exports are doing well.