The US is facing soaring trade deficits, but rising energy prices are a bigger danger

• The European Union and China are pocketing increasing surpluses on U.S. trades.
• Washington should negotiate instead of shooting tariff hits.
• If unchecked, rising energy prices will fire up inflation and lead to recession.

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German Chancellor Angela Merkel and U.S. President Donald Trump arrive for the group photo at the G7 Taormina summit on t

America’s foreign trade deficits on goods transactions are getting worse.

After an increase of 7.7 percent in 2017, those deficits were growing in the first five months of this year at an almost identical annual rate.

Particularly disappointing is the fact that there is no progress at all in bringing trade deficits down with the European Union and China. The deficit with those two large economic systems came in at $218 billion during the January-May period, accounting for nearly two-thirds (64 percent) of America’s total trade gap. That deficit was 11.3 percent more than recorded over the same interval of last year, and, at an annual rate, it comes close to half-a-trillion dollars.

Looking at the detail of these numbers, one can clearly see that trade deficits with the EU and China, growing at respective annual rates of 15 percent and 10 percent, are driven by a strong and unrelenting import penetration of American markets by European and Chinese companies.

No trade respite in sight

On current evidence, the short-term outlook for American foreign trade is not good for reasons of (a) different growth dynamics, (b) confrontational trade policies and (c) the political and security fallout exacerbated by intensifying trade disputes.

Barring an inflation-induced recession, of which more later, the U.S. aggregate demand components — household consumption, residential investments and business capital outlays — are underpinned by high employment, increasing inflation-adjusted after tax incomes, low credit costs and targeted fiscal incentives.

An anticipated economic growth in the area of 2.5 to 3.0 percent for the rest of this year would still be more than an entire percentage point above the estimated non-inflationary potential of the U.S. economy. That strong demand pressure will continue to spill over into the rest of the world, and will support America’s vigorous imports of foreign goods and services.

That’s music to European and Chinese ears.

The Europeans — more specifically, export-driven German businesses — are looking forward to increasing American sales at a time when the EU growth has topped out and expected to decelerate in the months ahead.

The Chinese could do things differently to reduce their unsustainably large dependence on U.S. markets. China can use more of its output to serve rapidly expanding domestic markets. It can also step up the geographical diversification of its export sales. Instead of that, China continues to flood American markets with its goods and services, pocketing a gigantic $375 billion surplus on American trades and apparently paying no attention to Washington’s warnings over the last two years.

But the time for warnings is over. Washington has now initiated a flurry of trade tariffs and sanctions affecting large segments of European and Chinese economies.

It seems that the Europeans, led by Germany, are relenting. Some good things in trans-Atlantic trade relations could happen even this week, as a prelude to broader trade agreements during the high-level consultations planned in Washington later this month.

Problems with China are much more difficult, in large part because vitally important trade relations are bound up in a complex web of “strategically competitive” political and security issues.

Trade disputes have become the proverbial “war by other means” — a long-anticipated clash by American sinologists who have never been able to give Washington an operationally sound advice.

But here we are, the U.S. wants to stop large wealth transfers to China and to protect its intellectual properties while (a) opposing China’s claims on its maritime borders, (b) keeping a virtual lock on China-Japan-South Korea trade and investment relations, (c) maintaining “creatively ambiguous” positions with respect to Taiwan’s quest for a quasi-sovereign status and (d) reinforcing close ties with a number of strategically important China’s neighbors.

The US is fit to compete

The current trade numbers are showing that difficult bilateral economic issues will linger on, alongside dangerous confrontations on Korean problems, Iran’s nuclear treaty, extraterritorial sanctions, and fundamental principles of the world order.

That no-war, no-peace state of U.S.-China relations is a result of so many irreconcilable “red lines,” where the American concept of “strategic competition” looks more fitting than China’s advocacy of “great power relationship,” “win-win cooperation,” “shared destiny of humankind,” etc.

In that context, it is absolutely essential that the U.S. maintains a steadily growing economy at the cutting edge of technological innovation, with investments in human capital through education, healthcare and vocational training. Washington must make it possible to bring back into productive labor force some of the 95 million Americans without jobs and a meaningful future.

Expanding the volume and quality of labor supply would increase the economy’s non-inflationary growth potential, and that, in turn, would accommodate a sustainably faster growth of demand and output in an environment of price stability.

At the moment, the economy’s physical limits to growth, set by the available stock and quality of human and (physical) capital, are at a dismally low 1.6 percent. The actual growth rate of 2.8 percent in the first quarter of this year exceeds those limits by more than a percentage point, indicating strong capacity pressures in labor and product markets.

Those pressures are reflected in actual inflation indicators that are currently at, or above, their target ranges. The immediate task, therefore, is to prevent accelerating inflation that would inexorably lead to rapidly rising interest rates, collapsing asset prices and a growth recession of unknowable amplitude and duration.

The soaring oil prices — marking a 13 percent increase over the last month — are the most serious threat to price stability. And the crucial issue here is whether the White House can rapidly get from Saudi Arabia those additional 2 million barrels per day that could stabilize, and reduce, the costs of energy.

Investment thoughts

The U.S. administration deserves credit for boldly moving to stop decades of rising trade deficits and foreign debt. It should do that by negotiating its unassailable trade case with Germans and the Chinese. Shooting tariff hits to force concessions is a road to nowhere.

Washington must also negotiate expanding oil supplies to keep the economy growing. It is frightening to think that soaring oil prices will fire up an accelerating inflation, push the Fed to tighten more and faster, sowing the panic in asset markets and setting the stage for an intractable recession.

It remains to be seen whether oil producers will agree. Only Russia, with its current output of 11 million barrels per day, and Saudi Arabia, pumping an estimated 10.1 million barrels per day, could provide those extra 2 million b/d to stabilize and reduce oil prices.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.