Why Does the U.S. Have a Trade Deficit?

The United States has an annual trade deficit with the rest of the world of about $700 billion. Most Americans view this as evidence that the U.S. is either not competitive in the world economy or that foreign producers are benefiting from unfair trade deals. But America does not have a competitiveness problem. It has an oil problem. Each year, the U.S. imports about 4.5 billion barrels of crude oil and petroleum products. At an average proce of $120/barrel, U.S. imports total $540 billion. In other words, about 75 percent of the U.S. trade deficit is really an oil import deficit. Outside of oil imports, U.S. exports and imports are close to equal, hardly a sign of a country that can't compete internationally.

In fact, U.S. exports have been growing at a rapid pace, rising 90 percent over the last six years, from $1 billion to $1.9 billion. Over the same time, imports have risen from $1.4 billion to $2.6 billion, widening the deficit. But again, oil explains much of the increase in import spending due to the quadrupling of oil prices and little change in oil consumption.

Oil and the Dollar

One driver of the increase in U.S. exports has been the decline in the value of the dollar. Since 2002, the dollar fell almost 40 percent against an index of other major currencies. The dollar has declined for the simple reason that the U.S. has been flooding the world with its currency through monetary expansion, government deficit spending, and consumer dollars spent on imports. The more dollars there are in the world, the less each dollar is worth.

Value of the Dollar and Oil Prices

While the decline in the dollar has helped U.S. exports, it has worsened the oil problem. One reason why oil prices have increased so much is because the dollar has fallen so much. If the dollar is worth less, then foreigners -- in this case oil-exporting countries -- demand more dollars in exchange for a barrel of oil. About half of the increase in the dollar price of oil is due to the decrease in the value of the dollar.

Policy Implications

What does this all mean? First, it means that general arguments against foreign trade are largely groundless. Certainly it's true that some American jobs are lost as a result of imports into this country, but American jobs are also gained because of the rapid growth in exports. Remember, taking out oil, the U.S. has essentially balanced trade. Moreover, the current rise in unemployment is mainly due to the decline in the housing market and the contraction in the credit markets, something that is an entirely home-grown problem.

At the same time, the oil deficit problem strengthens the argument for reducing oil consumption and encouraging the use of alternative sources of energy. Currently, the U.S. uses about 8 billion barrels of oil and other petroleum products a year, 3.5 billion produced domestically and 4.5 billion imported. Even if the U.S. were to increase its oil production to 4 billion barrels a year (no easy task) we would still be importing half our oil. The problem would lessen, but oil imports would remain a major negative for the U.S. economy.

Reducing oil consumption, on the other hand, could result in a one-for-one decline in U.S. oil imports. High gas prices are doing some the work for us, but given the inelasticity of gasoline demand, it's an expensive way to cut down on our use. Hybrid cares are the rage now, understandably, and some small pure electric cars are heading to the market. Longer term, electric cars will likely become more powerful and there is also the possibility of hydrogen-fueled vehicles as well.

What about ethanol, produced from U.S.-grown corn. Its production cuts down on our use of oil, but its hardly a panacea. First, ethanol production requires a lot of resources -- land, water, etc. Second, it's not the most efficient bio-fuel available. Cane sugar-based more efficient and cheaper to produce than corn. Brazil is the world's leading producer of sugar cane ethanol and uses it to satisfy about half of its automotive fuel demand.

But the importation of Brazilian sugar cane is restricted in the U.S., as protection both to U.S. sugar and ethanol producers. Consequently, our sugar imports are low and our oil imports are high. Not a great trade, that one.