Thanks to yesterday’s release of the full transcripts of previously classified Federal Reserve Board meetings from 2009, Fed chief Janet Yellen’s reputation as an economic forecaster is going off the charts. Before ascending to the chair, and at the height of the financial crisis and the depths of the ensuing recession, Yellen’s assessment of the downturn’s severity (and the need for an extraordinary policy response) seem to have been among the most accurate at the central bank.
Yet the transcripts also reenforce a point that I’ve made recently that Yellen’s understanding of U.S. trade and its effects on growth and recovery leave a lot to be desired.
At a key March 17-18, 2009 meeting, Yellen spotlighted trade as one of her main reasons for fearing that “we may not even get a modest U-shaped recovery, much less a V-shaped one.” In her view, “the global nature of the recession means we can’t rely on foreign demand to provide support for our economy. Instead, a sharp downturn abroad and recent dollar appreciation have driven down our exports and exacerbated our downturn.”
But there are two big, related problems with this analysis. First, foreign demand has almost never provided support for the U.S. economy on a net basis. Second, the reason is that, for so long, so many foreign economies have depended so heavily for their growth on boosting their trade surpluses with the United States. For various reasons, growing by fostering their own demand hasn’t been their top priority. And these points reinforce my longstanding insistence that the only way in which trade can contribute to American growth (and hiring) on net is for the trade balance (which of course includes imports and exports) to improve.
The futility of relying on foreign demand as a U.S. growth engine, whether during recessions or expansions, is made sadly clear by examining the record. Let’s start with the two near-back-to-back recessions of the early 1980s – from the first quarter of 1980 to the fourth quarter of 1982.
During that painful slump, U.S. exports fell by 10.65 percent in real terms, so foreign demand clearly was no help. Even worse, real imports during that period dropped only by 7.45 percent, meaning that the American trade deficit worsened, and trade’s overall impact was to weaken growth, not enhance it.
The 1980s expansion helped Ronald Reagan win a second presidential term, but foreign demand had nothing to do with the economy’s success. In fact, over its duration, from the first quarter of 1983 to the second quarter of 1990, the growth-killing real trade deficit more than doubled. Inflation-adjusted exports rose by nearly 91 percent, but the greater amount of imports increased even more – by more than 92 percent.
During the short early 1990s recession, a narrowing after-inflation trade deficit did contain the economy’s contraction. But foreign demand wasn’t the main reason. U.S. exports indeed grew by 2.27 percent in real terms between the second quarter of 1990 to the first quarter of 1991. But the heavy lifting was done by the 4.19 percent decline in inflation-adjusted imports, which again were greater in absolute terms.
Moreover, a burgeoning real trade deficit slowed the long 1990s expansion, too, as the inflation-adjusted gap between exports and imports grew nearly 18-fold, and American domestic demand was driving so much of global growth that then-Treasury Secretary Lawrence Summers publicly likened the world economy to a plane flying on a single – U.S.-made engine.
Another, even briefer, recession stuck between the first and fourth quarters of 2001. But this time, the contraction was aggravated by a growing real trade deficit. And once again, foreign demand disappointed, as after-inflation U.S. exports decreased much faster (10.88 percent) than imports (6.22 percent).
During the recovery that followed, this pattern was actually reversed, as export growth between the fourth quarter of 2001 and the fourth quarter of 2007 was faster in real terms (53.55 percent) than import growth (42.66 percent). But by then, the difference between the two in absolute terms had grown so great that the trade shortfall still increased markedly– once more hamstringing the expansion. Moreover, the gap was so enormous that Summers again warned, along with other notables, that if it remained unaddressed, a serious adjustment was inevitable.
The financial crisis and Great Recession proved such predictions right. During the deep slump, when Yellen laid out her 2009 expectations, the real trade deficit finally nosedived – from $622.6 in the fourth quarter of 2007 to $366.3 billion in the second quarter of 2009 on an annualized basis. Both import and export flows were hammered by a nearly paralyzed global credit system. As Yellen foresaw, foreign demand never came to America’s rescue. Although the real trade deficit’s shrinkage did prop up inflation-adjusted gross domestic product, the main reason was an 18.54 percent crash in exports that dwarfed even the sharp 10.33 percent drop in imports. But as she didn’t seem to realize, these results were nothing new.
Since the current recovery began in that second quarter of 2009, the U.S. trade deficit has resumed its growth-retarding rise in inflation-adjusted terms, with imports so far up more (36.28 percent) than exports (33.09 percent) even though the nation is buying much less oil from abroad. GDP growth is satisfying no one (except, perhaps, President Obama, who believes that the economy has “turned the page”), interest rates are nearly at the zero bound, and Yellen’s Fed is running short of policy tools for preventing another slowdown, other than resuming the Quantitative Easing (QE) bond buying that was no panacea the first time.
Reducing the trade deficit would bring America the debt-free, healthy growth it urgently needs. But given Yellen’s cursory familiarity with and interest in the subject, hearing this message from her would be a major surprise.