By Jason Simpkins
Associate Editor

The trade deficit narrowed significantly in the month of March, as developing markets took advantage of a weak dollar and stocked up on American goods.  

The gap shrank 5.7% from a revised $61.7 billion in February to $58.2 billion, the Commerce Department reported. Imports decreased 2.9% as the country experienced sluggish growth over the past six months, and according to some, slipped into a recession. It was the biggest drop in imports since December 2001.

Exports dropped by 1.7%, but that decline followed February’s record high export total of $151.1 billion. March’s export total of $148.5 billion was the second biggest ever. Demand for American goods in the European Union and Latin America hit record highs in March. And the trade deficit with China shrank to $16.1 billion, its lowest level in two years, as exports to the country soared to their second-highest level ever.

A weak dollar provided a boost by making U.S. goods more appealing to foreign buyers. The dollar was down 9% against a trade-weighted basket of currencies in the 12 months ended March 31, Bloomberg News reported.

However, the weak dollar also proved to be a double-edged sword, as inflation at home is tapering consumer spending. And that pattern could develop into a global trend fairly quickly.

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"Under normal circumstances a decline in the real adjusted trade balance and the improvement in the overall picture for output would be a cause for a positive reaction in the market," Joseph Brusuelas, chief economist for Merk Investments LLC, told MarketWatch. "However, the data inside the March trade report suggests that the rapid rise in headline inflation has sharply reduced the appetite of U.S. consumers for goods and services across the board."

Headline inflation jumped 4% in March, up from 2.8% a year prior. Meanwhile, U.S. economic growth has stagnated at 0.6% over the past two quarters. The global economy has held up so far, but with inflation rising around the world, the global economy is facing a significant dilemma. 

In China, producer prices edged up to 8.1% in the month of April and consumer prices have reached an annual rate of 8.3% – their highest level in 11 years. Wholesale inflation in India has more than doubled since November. Government data released Friday showed the wholesale price index for the 12 months ended April 26 rose at its fastest pace in three and a half years, climbing from 7.57% to 7.61%. 

Inflation in the 15-nation eurozone rose 3.6% in March, its fastest pace in nearly 16 years, prompting the European Central Bank to hold its benchmark lending rate steady at 4.0% despite an aggressive rate cutting campaign in the United States.

"In the euro area, the sharp rise in inflation and concerns about potential deterioration in inflation expectations are dampening consumer confidence and spending," John Lipsky, the International Monetary Fund’s first deputy managing director, said in a speech in New York Friday. "The inflation outlook appropriately is central to the ECB’s policy considerations."

"This inflation speed-up must be taken seriously as it creates potentially significant challenges to economic stability," he said.

Rising consumer and producer prices correlated with the strong run on commodities investors have seen take place over the past year. Food staples such as corn, wheat, rice and soybeans have all hit record highs, inciting food riots in many developing nations.

Increased industrial demand from China and India has driven up the prices of iron ore, copper and aluminum. And energy prices have skyrocketed along with demand for coal and oil. In fact, the price of oil has nearly doubled in the past 12 months and hit a new record high above $125 a barrel Friday.

If inflation continues to rise, consumers worldwide will be forced to reduce spending and derail global growth.

While they’ve gotten a boost from the diving dollar, "the factors underlying the current price shifts for energy and commodities appear to be fundamental in nature," Lipsky said. "This means that much, if not most, of the recent price increases are likely to prove durable."

He added that central banks must be prepared for a "decisive response" to inflation if they are going to preserve economic growth.

News and Related Story Links:

• CNNMoney:
  Trade gap narrows in March

• MarketWatch:
  Trade gap narrows to $58.2 billion on fewer imports

• Bloomberg:
  U.S. Economy: Trade Deficit Narrows as Demand for Imports Wanes

• Bloomberg:
  IMF Says Inflation Back After Years of ‘Quiescence’

• Money Morning:
  China Officials: Inflation Too Hot, Rates May Rise