Guest essay by Eric Worrall
One thing which wasn’t made clear during the recent US election was how important domestic US energy production and fracking is to reducing the trade deficit, which in turn feeds through to inflation, interest rates and the continuance of affordable home loans.
The following is from 2019, but it is just as relevant today.
Growing U.S. trade deficit points to suppressed inflation: Kemp
By John Kemp
MARCH 7, 2019
LONDON (Reuters) – The United States ran a trade deficit on goods and services of $621 billion in 2018, up more than 12 percent compared with the previous year, but still below the record $761 billion set back in 2006.
The steadily worsening merchandise deficit is a sign domestic demand is outstripping the economy’s productive potential, with excess demand leaking abroad through a widening trade gap and a higher exchange rate.
The deteriorating external position is being masked somewhat by the shale revolution and the associated surge in domestic oil and gas production, which has slashed the bill for petroleum imports.
The petroleum deficit was just $53 billion last year, down from a peak of $386 billion in 2008 and $271 billion in 2006 (“U.S. international trade in goods and services”, Census Bureau, March 6).
Increasing deficits are a sign of suppressed inflation, as domestic consumption and investment outstrip the growth in the economy’s productive capacity.
The federal government has significantly loosened fiscal policy over the last two years, cutting taxes while government spending has continued to increase at more than 4 percent per year.
The Federal Reserve has responded by tightening monetary policy to keep inflation in check, pushing up the exchange rate and exacerbating the trade gap.
Read more: https://www.reuters.com/article/us-usa-economy-kemp-idUSKCN1QN2BF
The point is, the trade deficit is a major driver of inflation, which in turn puts upward pressure on interest rates.
The US annual trade deficit is around $600 billion. This is not great, but it would be a lot worse without fracking. Fracking ended the need for around $300 billion per annum of fossil fuel imports, because fracking allowed the US fossil fuel industry to produce vast quantities of domestic fuel which previously had to be imported.
As the economy falters in the wake of Coronavirus, political and Fed focus will be on the recovery. Nobody will care in the short term what happens to the US trade deficit.
But sooner or later the structural US trade imbalance will have to be addressed, either by bringing home manufacturing jobs, or by cooling down the domestic economy through rate rises and tax hikes.
Any rise in interest rates would in time be passed on to home buyers.
The fracking premium, the $300 billion per annum or so which the USA does not have to spend on fuel imports, makes a big structural difference to the US balance of trade and the productivity of the US economy. By driving down the trade deficit, fracking helps to mitigate the need for future interest rate rises and tax hikes.
Note: the article mentions that rate rises at the time the article was published exacerbated the trade deficit. This is because the rate rises lowered the price of imports by raising the value of the US dollar, but rates did not rise enough to cool the economy by squeezing people’s hip pockets, so people started buying more imports.
President Trump appears to be steering a narrow path to permanently increasing the productive capacity of the US economy by bringing manufacturing jobs home, which could reduce or eliminate the trade deficit by addressing the $900 billion imported goods deficit, without the pain of having to slow the economy by imposing tax hikes or further rate rises.