December Trade Deficit and January Small Business Optimism

KEY DATA: Deficit: $1.4 billion wider; Exports: +1.5%; Imports: +1.6%/ NFIB: -1.8 points

IN A NUTSHELL: “The U.S. economy may have recovered sharply in 2021, but a lot of the improvement was used to buy foreign products.”

WHAT IT MEANS:  The world economy is coming around, as Omicron starts to burn itself out and restrictions are eased.  That is the good news.  The bad news is that the U.S. continues to ship its recovery out to the rest of the world.  In December, the monthly trade deficit widened again, reaching a record high.  Records are nice, but not this one, as it represents growing funds flowing out of the country.  Much of that income went to China, as our exports to that country declined but our imports soared.  Both export and imports increased in December, which is what we want to see.  We sold more of just about everything to the rest of the world.  Only food exports declined, with soybean sales leading the way.  As for imports, our demand for consumer goods, especially cell phones, vehicles and capital goods jumped.  Our purchases of industrial products (largely petroleum) as well as food were down.  For all of 2021, the deficit widened by $182.4 billion, or twenty-seven percent.  That should put into perspective the magnitude of the widening of the deficit. 

Small businesses optimism, not surprisingly, continues to falter.  The National Federation of Independent Businesses’ Index fell in January and the level is not too far from where it was in March 2020.  Firms continue to be battered by rising input and labor costs and a shortage of qualified workers. The report noted that: “The net percent of owners raising average selling prices increased 4 points to a net 61 percent seasonally adjusted, the highest reading since Q4 1974.”  Can you say inflation?  The respondents don’t think this is a very good time to expand, largely because of the rising costs of doing business.   

IMPLICATIONS: There wasn’t a lot of good news in today’s data.  Yes, we are selling more abroad, but we are also shipping a lot more of the income that has been generated by the recovery out of the country.  That is slowing growth and there is little reason to expect that to change.  On the inflation front, when there is a record share of small businesses saying they are raising prices, that is a clear indication that inflationary pressures have spread across the economy.  I have noted several times that the rate of inflation will ease as we go through this year.  The growing numbers of firms of all sizes raising prices is a warning that pricing power may be starting to become embedded in the economy.  And once firms know they can raise prices, they are likely to hold onto that power as long as possible.  The Fed will soon embark on the process of raising rates.  The members seem to be signaling that the hikes may not be aggressive, at least to start.  I have argued that the inflation risks are great enough that it would make sense to raise rates not just by one-quarter percent, but by one-half percent to start off.  Economists have started a forecasting war, trying to see who can come up with the highest increase this year.  The latest I have seen is for seven, yes seven 25-basis points increases, for a total of 1.75 percentage points in 2022.  My view is that by coming out with a higher-than-expected initial rate hike, the FOMC might be able to send a message that it means businesses, buying itself some time.  Instead, we could see a repeat of the “slow but steady wins the race” approach.  That could lead to a greater than necessary ultimate increase in rates, as it allows households and businesses to plan for the slow increases and adjust accordingly, forcing the Fed to keep hiking rates.  The Fed needs more of a hammer than a fly swatter approach.