HOW EXPORTS COULD SAVE AMERICA / BARRON´S FEATURE

MONDAY, JULY 20, 2009

FEATURE

How Exports Could Save America

By JONATHAN R. LAING

Top economist Jim Paulsen argues that a shrinking U.S. trade deficit will translate into much stronger-than-expected GDP growth.


PERHAPS IT'S BECAUSE HE OPERATES FAR from Wall Street in the Midwest bastion of Minneapolis. But Jim Paulsen, chief investment strategist for Wells Capital Management, has long gone his own way in making stock-market and economic forecasts.

Like anyone playing this daunting game, he has had his share of home runs and strikeouts. He ruefully admits to "blowing it" by failing to sense the ferocity of the ongoing U.S. credit crisis and its baleful impact on financial markets and U.S. economic performance. Yet he nailed the strong economic recovery and stock-market rebound that ensued after the tech bust and the Sept. 11 attacks earlier this decade.

These days, he is charting yet another idiosyncratic course in the face of overwhelming economic lassitude and dark stock-market sentiment. For he envisions a far more ebullient bounce in gross-domestic-product growth next year and in the years ahead than many commentators expect: 3% to 3.5%, rather than the "new normal" economic growth of just 1% to 2% posited by the likes of Pimco's bond maven Bill Gross and many stock strategists.

According to Paulsen, this stronger growth should propel corporate profits, and therefore stock prices, to higher-than-expected levels. "Corporations are expecting slack growth in coming years, and have hunkered down by purging inventories, downsizing workforces and even cutting wages to prepare," he explains. "Just imagine what the earnings leverage will be if GDP growth and, thereby, revenues turn out to be much greater than expected. We're really spring-loaded for upside surprise -- rather than nuclear winter."

THE ENGINE OF THIS GROWTH WILL come from a source normally ignored or given short shrift by most forecasters: the U.S. trade balance. To materially add to U.S. GDP growth, our trade deficit, representing money spent on imported goods and services over revenues garnered by our exports, doesn't even have to turn positive. Exports just have to keep rising relative to imports. In other words, any improvement in net exports will, in and of itself, improve GDP growth.

For example, real net exports already have been adding 0.5% to 1.5% to GDP since 2007 despite still being in negative territory compared to imports. This was all the result of the trade deficit improving from $650 billion, or nearly 6% of GDP, compared to recent readings of under 3%. As Paulsen puts it, "The phenomenon is one of addition by subtraction, as the negative trade balance detracts less from GDP growth over time, compared to past periods. Over the next decade, GDP should get a big boost from U.S. trade moving into rough balance between exports and imports."

As a result, net exports should be able to supply about one percentage point annually to overall GDP growth over the next decade, rather than subtracting a similar amount from economic growth, as it has for much of the past two decades amid consistently poor U.S. trade performance.

That would compensate for an expected decline in households' contribution to economic growth from the more-than-3% level during the expansions of the 1992-2000 and 2003-06 periods to, say, just one percentage point during the coming expansion. Paulsen readily concedes that not much more can be expected from consumers these days, who are still weighed down by burdensome debt and dramatically reduced net worths.

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He gets to his GDP-growth expectation of 3% to 3.5% by assuming business investment will continue to contribute about one percentage point to growth. And any shortfall in business spending in the next couple of years will be more than made up for by increased government spending spurred by the recently passed stimulus bill.

LARGE TRADE DEFICITS have bedeviled the U.S. for much of the past 20 years. Although puritanical critics have attributed these imbalances to a nation content to live beyond her means, Paulsen sees other factors at work. For one thing, most U.S. administrations over that period, and even during the 1980s, favored a strong-dollar policy (at least until 2002). This was in reaction to the economic traumas of the '70s when the U.S.'s weak-dollar policies helped spur hyperinflation.
Likewise, the U.S. also closely hewed to free trade, even though the policy, along with a strong dollar, cost the nation dearly in terms of manufacturing jobs. Foreign goods displaced U.S. products both here and abroad. This was a major reason why real annual GDP growth from 1982 through the end of 2006 averaged about 3.3%, while such growth from 1950 to 1980, when trade deficits weren't a problem, approached 4%.

According to Paulsen, foreigners in recent decades were capturing some fruits of the U.S.'s consumer spending binge.

Yet Paulsen sees a silver lining to this leakage of U.S. demand to overseas.

In the process of gorging on overseas goods and services, the U.S. by happenstance fired up emerging economies such as China, Korea, Taiwan, India, Brazil and Mexico to build their productive capacities and spawn their own middle classes and consumer cultures. Paulsen has long called this trend the U.S.'s "emerging-market Marshall Plan."

In the strategist's view, the emerging-market demand will constitute "an incredible asset" for U.S. and other developed nations' goods and services. So far, the post-2002 weakening of the dollar has only helped U.S. trade competitiveness versus developed trading rivals such as Japan, the European Union and the U.K.

That is because many emerging-world nations have been allowed to peg their currencies to the dollar -- or, like China, have made only desultory moves to strengthen their currencies. But U.S. trade competitiveness should benefit mightily from the likelihood that these currencies will no longer be able to maintain their pegs at ridiculously low levels.

THE EMERGING NATIONS FIGURE to lose their cost advantages in other ways, too. Their wage costs will inevitably rise as their economies heat up.

"Also, the West will demand higher pollution-control standards, worker protections and product-safety measures in order for these countries to have unfettered access to Western markets," Paulsen says.

Stock-market strategist and economist Edward Yardeni of Yardeni Research, for one, sees much merit in Paulsen's contention that a declining U.S. trade deficit will be an engine of GDP growth over the next couple of years.

So far, according to Yardeni, the contribution has come from exports' dropping more slowly than imports. But that changed in the May trade numbers, released in July. The figures showed that U.S. exports of goods and services for the month had actually risen by $1.9 billion from the previous month, to $123.3 billion -- while U.S. imports continued to slide. As a result, the trade deficit dropped on a month-over-month basis, and even more dramatically year-over-year.

Paulsen sees yet other favorable news on the trade front. He tracks on a trailing 12-month basis the trade balance between the U.S. and leading emerging-nation players: China, India and Mexico. While the U.S. still suffers yawning deficits with these low-cost rivals, the long, deeply descending line has started to fish-hook upward in recent months -- for the first time in the 15 years he has kept the data.

The Bottom Line

Improvement in net exports should supply about a percentage point annually to overall GDP growth over the next decade, rather than subtracting a similar amount, as it has in the past.

Of course, this would only stand to reason. The U.S. consumer, buried in debt and suffering from illiquidity, can't fulfill his usual role as the engine lifting the global economy out of its economic funk. The need for folks in the U.S. to rebuild savings will keep them from reloading their credit-card debt and hitting the malls in the near future. And now, thinks Paulsen, something else is starting to happen:

Repatriated U.S. trade flows will bolster the U.S. economy as American consumers boost their savings rates.

If that is the case, then the U.S. would have something to show for its emerging-market Marshall Plan -- unintentional though it was.

Instead of facing a decade of substandard "new normal" economic growth and languishing asset markets, the U.S. could once again see the good, old normal.