Deficit Disorders

There has been much debate over the U.S trade deficit – some see it as a sign of the "decline of America," while others insist that it reflects the strength of our country. Bill Bonner shows us why seeing this deficit as an asset is America’s downfall…

As we mentioned yesterday, the noise on the issue of national accounts is deafening. Every politician, economist, and goofball analyst with access to an editorial page seems to have an opinion. Here we offer an anti-opinion. Our purpose is neither to explain the current account more clearly nor to guess about what will happen to the dollar. No, we set a much lower goal for ourselves; we only want to show that almost all the commentators and policymakers are numbskulls.

We begin by reminding readers that the U.S. trade deficit hit a new record in January, at $58.3 billion, an amount that "exceeded everyone’s worst expectations," said The New York Times. The deficit reached over $650 billion last year, requiring 80% of the entire world’s savings to finance it. The world has never seen such a huge red number in international trade and doesn’t know what to make of it. It is a sign of the "decline of the American empire,’ say some of the commentators. Others take as an emblem of America’s strength.

Whence cometh this trade deficit?

It ariseth when Americans buy more from non-Americans than they sell to them. Each day that passes, Americans buy (net) about $2 billion more in foreign imports than they make in overseas sales. That U.S. businesses are more profitable than their Asian counterparts makes no difference. That the American economy is the most dynamic, flexible and delicious confection ever put up on God’s green earth is as irrelevant as tree rings. That foreigners want a piece of America is flattering, but it is also as much a non sequitur as hemorrhoids.

Nor does it especially matter why Americans overspend. They have their reasons. But even if they didn’t, the result would be the same. Each day, including weekends, more goes out than comes in. Ships, plying their routes from East to West – that is, leaving North American ports headed for China, Japan and the rest of the Far East – glide across the water. They are lightly charged with lumber, raw materials, tools, and food. Some are empty. As they make their way across the broad Pacific, they cross other ships headed in the opposite direction. These ships leaving the Orient on their way to Seattle or Long Beach ride lower in the water, for they are full up to the gunnels. There are cell phones, TVs, toys, gadgets, trinkets, clothes, and appliances – all the flotsam and jetsam upon which America’s standard of living now rests.

US Trade Deficits: Only the US Could Get Away With This

If the nation were a corporation, the difference between what came in and what went out – in dollar terms – would be the measure of its "loss from current operations." If it were a family, it would be the rate at which it impoverished itself. If it were a business, running such an imbalance for so many years – it would have gone bankrupt long ago. Even a lesser nation would have run into trouble a long time ago. Only a nation with the world’s reserve currency could have gotten away with it.

It is not particularly important that the U.S. economy is "growing faster than its competitors," as Mr. David Malpass claims (in the Wall Street Journal), even if it were true. Besides, the U.S. economy is growing at less than half the rate of China. Nor does it matter that Asians have "no choice" but to buy U.S. dollar assets, as other commentators maintain. Nor is it pertinent that the foreign investments represent a kind of "tribute" paid to the imperial power.

The grim and unyielding fact is that each day, Americans are about $2 billion dollars "richer" in SUVs, flat screen TVs, and other consumer gee-gaws that come mostly from Asia (where the trade deficit is concentrated), while the Asians are $2 billion richer in U.S. financial assets, notably Treasury bonds.

Since 1990, foreigners have acquired $3.6 trillion worth of U.S. assets as a direct consequence of the trade deficits.

US Trade Deficits: Big TVs or Treasury Bonds?

Individually, of course, this makes no great difference. We only bring it up to mock others who brought it up before us. A man decides for himself if he’d rather have a big TV or a Treasury bond. It is not for us to say he’s made a good choice or a bad one. But Americans are not merely trading a financial asset for a consumer asset. They have few financial assets to trade. Since the Reagan administration, savings rates have dropped. People do not dip into capital in order to spend it at Wal-Mart. They dip into debt. With no savings to spend, they cannot trade a financial asset for consumer gee-gaws. So, they must trade a financial liability.

This is just another consumer preference, of course. It is no concern of ours if a man decides he wants a big-screen TV so badly he’s willing to go into debt to get it. He would rather have the additional debt than forego the TV. This preference has become so wildly popular that it takes our breath away. Each day, collectively, people buy $2 billion worth of stuff they can’t pay for. They will pay for it in the future. Or someone will.

Again, we have no problem with that.

But every public spectacle begins with a lie. Later it develops into mass illusion, self-congratulation, hallucination, farce and…finally…disaster. Until the disaster comes, you never know quite where you are. Because for every imbecility that comes along, there are dozens of hallucinators who are eager to put it over on people…and at least half the population is ready to believe it.

US Trade Deficits: Americans Get Poorer Every Day

So, almost everyday we see a piece in the Wall Street Journal explaining that trade deficits are no trouble. And at a certain macro-economic level, they are no trouble at all. At least, as long as someone keeps lending money, they are no trouble. But even while the money flows…Americans get poorer every day.

Some kibitzers point out that the United States ran trade deficits for much of its early history…and that fast-growing countries always have current account deficits. After all, they are building something for the future…factories, plants, machines… all of which take capital. Then, when the factories are built, they produce earnings and profits, which are used to pay back the debt. In this instance, the debtor comes out ahead.

Oh, the flattering reverie of it…but when did you last see a factory…or refinery…or mine… under construction in America, dear reader? The last one we recall was a shiny new brewery outside Baltimore – and that must have been 40 years ago. Since then, it has gone out of business!

The distinguished economic journal, Bank Credit Analyst, based in Montreal, looks ahead and sees nothing but good news. BCA believes the information revolution has many more good things to give us. We’re not aware of any benefits, yet, from the information revolution…but we’re prepared to believe there might eventually be some. But information is notoriously light on its feet.

We read that more and more U.S. tax forms – which are nothing more than information – are being processed in India. And now comes word from Business Week that American companies are actually outsourcing more and more of the "information" component of modern products. They no longer go to Taiwan and ask the locals to "make this." Now, they go to Taiwan to see what the locals are making that they can sell back home. More and more, U.S. companies don’t even participate at the design stage. "Many just take our products," said one Taiwanese manufacturer.

What we are seeing, says Paul Craig Roberts, is the "rapid transformation of America into a Third World economy." American firms are increasing left with only brands to market. But even those won’t last forever, after customers realize that the real innovation, design and manufacture genius is overseas. Just as car buyers took up new brands as quality increased in Japan, they will take up new brands in other industries. Soon, Americans will not only want to spend on foreign-made good, they will have to.

Meanwhile, the Newman brothers, Dan and Frank, point out that the outflow of dollars is no cause for concern, because the dollars just come back to us. As we conceded yesterday, they do…or, they will. But they don’t come back the same good-natured working stiffs they were when they left. Instead they come back in finer clothes, with finer manners, and with a better accent. They come back as renters. Instead of helping the average man earn a living, in other words, they make it harder for him. For now, they must be supported too. After all, interest must be paid on debt…or compounded into more debt. Either way, day by day, the burden just grows heavier.


Bill Bonner
The Daily Reckoning
March 18, 2005

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

Near the end of the tech bubble an e-trading firm ran an arresting advertisement. It showed a doctor peering down at a trader on the operating table…the doctor says,

"Why…he’s got money coming out the wazoo!"

Five years later, you could replace the E-trader with a house flipper.

California house sales hit a new record in February. Housing starts nationwide are at a 21-year high. All over the 50 states, people are buying, flipping, refinancing.

Last year, according a figure we read this morning, a total of $640 billion was "cashed out" of houses. Americans have more new income coming out the wazoo from the residential house price boom than they did from their jobs.

The numbers seem to converge in a curious way. Last year’s current account deficit was $665.9 billion. Total U.S. overseas indebtedness increased by a disturbing $666 billion. Yet all rest on the same phenomenon – the willingness of American consumers to go further into debt in order to buy more things from overseas. (More on that, below…)

But as long as the price of housing goes up…is there any reason to worry? The money keeps coming out the wazoo, doesn’t it?

Our friend in London, James Ferguson, believes there’s a lot more money in the wazoo waiting to come out. Compared to prices in England, U.S. property prices are low. Of course, compared to the United Kingdom, everything in the United States is cheap. English magazines even suggest that property buyers look to America, France, Berlin…or Eastern Europe if they want to find a decent house at a decent price.

(By the way…to us, Berlin looks as though it might be a good deal. Compared to other "brand name" cities, Berlin is cheap. Blood is practically running in the streets…with the highest unemployment in Germany since Adolph Hitler came to power. When a good city is cheap, young artists and entrepreneurs move in. Soon, the place has a "buzz" about it. Then, prices move up.)

Maria and I went out for breakfast in London yesterday. We went into a cheap, unpretentious diner. Two cups of tea, two pieces of toast, two fried eggs, and two glasses of orange juice – $17. We’d expect to pay that, and more, had we gone into the Savoy or the Connaught. But this was one of those dives run by people who don’t speak English, where they only clean the counter once every other week.

Houses in London are even more expensive than orange juice. But they’re no longer going up. Prices have been stagnant since summer. At first, buyers are reluctant to cut prices. So, it takes a while for a bear market in property to manifest itself. Many analysts think they are already headed down.

In Australia, too, the property boom seems to have come to an end. Not that prices are falling – yet. But today’s International Herald Tribune reports that they are no longer rising. One of Sidney’s finest homes, Boomerang, was sold for 20.7 million Australian dollars, not a penny more than it brought three years ago.

We don’t know when houses will top out in America. Perhaps James is right. Maybe the trend has a long way to go before it comes to an end. On the other hand, we note that homebuilders already seem to have topped out. And Fannie Mae, the largest mortgage finance company in the world, is clearly in a major downtrend. And who can afford a house in California anymore? While prices have gone up at 5 to 10 times the rate of inflation, real incomes have actually gone down. This is a trend that can last forever. And as Herbert Stein once remarked: If it can’t go on, it won’t.

You can lose a lot of money by selling too late. So can you make a lot by selling too early.

A simple investment formula, based on effluents and body fluids: Be a seller when money is coming out the wazoo; be a buyer when blood is running in the street.

More news, from our team at The Rude Awakening…


Eric Fry, reporting from Manhattan:

"Despite a bumper crop and record inventories last year, corn prices have managed to rise. This action is an anomaly to some traders…but not to The Rude Awakening. We have an explanation…and it involves a banned substance!"


Bill Bonner, back in Paris, with more random thoughts of no particular importance…

*** A note of apology from our Baltimore office:

"The server that sends out our newsletters has been under the weather for the last couple of days, so no one received yesterday’s issue of The Daily Reckoning. Our IT team has been working diligently on the problem and if you’re reading this, it has been fixed.

*** A new bankruptcy law is being widely discussed. As near as we can tell, it is a Dred Scott decision for debtors…bringing the force of federal law to the old adage: "The borrower is slave to the lender." A whole generation of Americans, enslaved to debt, will find it more difficult to escape their credit card overseers.

*** Why learning how to build wealth is like learning Jujitsu…

We knew wealth came from blisters. And from sweat. And getting up early. But painful headlocks? A copy of Michael Masterson’s new book, Automatic Wealth, found its way into our hands…

"I like Boca so much as a teacher and as a friend that I want to give him the secret of getting rich in a single one-hour lesson," writes Michael. "But I can’t. I can explain a few concepts. I can even tell him, in an abbreviated way, what I consider to be the most important things he must do. But an hour’s worth of talk won’t make him wealthy, any more than a single hour of jujitsu with him will make me a black-belt grappler.

"’You are a great teacher,’ I told him. ‘In a single hour, you can teach me many things. You can teach me your best takedown technique, your favorite choke, your latest arm bar or footlock. You can do all that and probably even tell me some of your top "secrets" about being successful at jujitsu, too.’"

"’But for that I must charge you a lot of money.’ (He was smiling.)"

"’Yes, you would. And you should. But if you gave me such a class, and I paid whatever you asked for it, would you then give me a black belt?’"

"’Well, no, my friend. You get black belt only when you can do.’"

"’And to be able to do…to be able to defeat white belts and blue belts and purple belts and even brown belts…what must I do?’"

"’You must practice, my friend. For that, you must practice."

*** Gold dipped below its $440 range yesterday. It closed at $339 an ounce. Investors have so much choice today. Buying gold is so far down on the list of possibilities; most investors have placed all their money or fallen asleep long before they get to it. Many investors have never actually seen an ounce of gold and have no idea what role it may play in the financial system. Certainly, it plays no role in their financial systems, and they have a hard time imagining that it ever would. It benefits from no new technological innovation. It holds no press conferences. It neither raises, nor lowers any interest rates. It makes no mergers or acquisitions, reports no earning, pays no dividends, fields no troops, writes no books, engages in no bonding retreats or office romances…and keeps its mouth shut. So, investors are likely to miss it.

So much the better. Gold is little known and relatively cheap.

*** "Daddy, I’m just not sure about this…and now he’s mad at me. And the whole thing makes me feel terrible…he wants me to be sure. This is the real thing for him, and He wants it to be the real thing for me, too. And so do I. I thought it was…for a while. But I’m not sure. Maybe it’s not the real thing. Maybe he’s not right. Maybe I’m just not ready for the real thing. But it just doesn’t feel like the real thing, even though I want it to feel like the real thing. Do you know what I mean? Oh Daddy, I don’t know what to do. I didn’t want to hurt his feelings. I tried to be honest with him the whole time. But I didn’t know what I felt. I just wasn’t sure. I told him that. But now…I think I’ve hurt his feelings. He’s not used to girls not being sure, if you know what I mean… but now, I’m more unsure than ever."

"Better talk to your mother," was Dad’s shrewd advice.

The Daily Reckoning