Unbalanced Trade

The Daily Reckoning PRESENTS: The trade deficit for December hit $61.2 billion, which is wider than those who wager on these types of things had anticipated. In an excerpt from his book, James Turk ponders the deficits and wonders when foreign investors are going to get fed up with the U.S. dollar. Read on…


If the dollar is still a functioning currency after America’s two-decade-long borrowing binge, what’s to stop it from functioning forever? Well, for one thing, we’re not alone in the world. Foreign investors have a say in the value of the dollar, and in the next few years they’re going to say some very unfortunate things.

As a major trading nation, the U.S. exports computers, software, movies, and food, among many other things. And we import just about everything you can imagine. When we buy more than we sell, we make up the difference-known as the trade deficit -by shipping dollars overseas. And in recent years we’ve been buying a lot more than we’ve been selling. After averaging a manageable $80 billion annually during the 1980s, the trade deficit soared into the $300 billion range in the 1990s. And by 2003, this figure had exploded to over $500 billion. That’s about 5 percent of GDP, a level that, when it has occurred in other countries in the past, has preceded a sharp decline in the value of the local currency.

Why are we buying so much more than we’re selling? One reason is that it’s a lot cheaper to make most basic products in places like China, where smart, highly motivated people will work for about a tenth the prevailing U.S. wage. So U.S. companies, in order to take advantage of this differential, are closing factories here and setting up new ones over there. Powerhouse discount-store chains, Wal-Mart especially, is driving the process by buying from a growing network of Chinese plants, passing some of the savings along to customers, and either driving its competitors out of business or forcing them to buy from cheap foreign sources as well. As a result, low-wage foreign factories are now flooding the United States with incredibly cheap stuff, much of which used to be made here. And where not so long ago our trade with China was more or less in balance, we now run a deficit that exceeds $100 billion annually.

But the imbalance goes beyond just China. We’re running annual deficits with Japan and the European Union of more than $100 billion and $50 billion, respectively. And of course, oil imports, mostly from the Middle East, seem headed nowhere but up. The inescapable conclusion is that U.S. consumers are addicted to a lifestyle that includes new cars, big houses, and slick electronic toys. And, as you know we’re willing to borrow whatever it takes to avoid cutting back.

Looked at from virtually any angle, the U.S. trade situation is unprecedented. The annual trade deficit is larger than the budgets of Social Security and the military, and twice as big as Medicare. Since 1953 America’s manufacturing base has declined from 30 percent of GDP (when the U.S. had a trade surplus, by the way) to about 15 percent today. Since 1985, the cumulative deficit has grown to about $4 trillion, or about $13,000 for each man, woman, and child in the U.S.

What are America’s trading partners doing with these dollars? Their central banks have been accumulating huge piles of dollars as “reserves” to support their own currencies, while foreign businesses have been buying U.S. real estate, stocks, and bonds. Foreign investors now own about $8 trillion of U.S. financial assets, including 13 percent of all U.S. stocks, 24 percent of corporate bonds, 43 percent of Treasury bonds, and 14 percent of government agency debt. By the end of 2003, about a third of Fannie Mae’s mortgage-backed bonds were being sold outside the United States. In the 1980s, the U.S. was the world’s biggest creditor nation, meaning that we had far more invested in other countries than those countries had invested here. But by 2003, foreign investors owned $9.4 trillion of U.S. assets, while U.S. claims on the rest of the world were only $7.2 trillion. The United States is now the world’s biggest debtor nation.

This willingness of foreign investors to recycle their dollars back into the U.S. economy explains the dollar’s stability in the 1990s. And as long as they stay willing, the supply and demand for dollars will balance, and its stability will continue. But what if foreigners change their mind and decide not to buy U.S. assets? It seems that we’re about to find out. Foreign direct investment-that is, the dollar value of U.S. assets bought by foreign investors-fell from $300 billion in 2000 to $135 billion in 2001, and then to less than $100 billion in 2002 and 2003. And the dollar, suddenly, began to struggle. In 2003, it fell by about 20 percent versus the euro and yen, and by 30 percent versus gold.

But 2003 was just a warm-up. Though foreign investors recycled fewer dollars, they still bought $80 billion of U.S. assets and ended the year with a bigger stake in the U.S. economy than ever before. What happens if they decide to actually start selling their Treasury bonds or Manhattan real estate? In all probability, the dollar will weaken further, causing foreign investors to look elsewhere for opportunity, causing the demand for dollars to dry up. We’ll have a rout on our hands, and the debt problem will go from potential to very, very real.

One cause of the U.S. trade deficit is that Europe and Japan are growing more slowly and buying relatively little from abroad. Why the difference in spending patterns? Because they have serious problems of their own. Beginning with Europe, when France, Germany, and their neighbors replaced their national currencies with the euro, they laid down a few ground rules in an agreement known as the Maastricht Treaty. Among them was the requirement that no Euro-zone country could run a deficit exceeding 3 percent of its GDP. But the treaty didn’t specify how they should achieve such fiscal prudence. It certainly didn’t force member countries to cut spending or adopt rational labor laws or business regulations. So Germany and France (again, following the standard ?at currency script) kept their massive welfare states and debilitating regulatory regimes and simply hoped that a common currency would make their economies productive again.

It didn’t, of course. Both economies, hamstrung by bloated governments and high taxes, have been more or less in recession since 2000.

And their budget deficits are consistently above the Eurozone limits, which puts them at the same crossroad as the United States: They can either cut spending and live with the consequences, or they can continue to spend too much, run ever-higher deficits, and print however much ?at currency is needed to cover the difference.

By mid-2003 it was clear that they, like the United States, had chosen the second road. Though the 3 percent of GDP deficit limit is written into the Maastricht Treaty, French and German leaders dismissed it as a mere “symbol.” And both signaled that henceforth they would pursue growth rather than austerity. As one news account put it in July 2003, “The French appear to have seized on Germany’s difficulties to push for an overhaul of the pact, which they view as an obstacle to President Jacques Chirac’s spending plans.”

The European Central Bank, meanwhile, has been following the U.S. Fed’s lead, cutting interest rates to the lowest levels in decades.

Japan, the world’s second-biggest economy, has been mired in a slow-motion deflation since its real-estate and stock-market bubbles burst in the early 1990s.The culprit: massive bad debts on the books of major Japanese banks that no one seems to know what to do with. If the banks write them off, they’ll be left with too little capital to finance new loans, and whole sections of Japan’s construction and financial sectors, currently dependent on bank credit lines, will implode. If the banks allow the loans to fester, the country will continue to stagnate. In a vain attempt to kick-start the economy, the central bank of Japan has cut short-term interest rates all the way to zero-that’s right, loans cost nothing over there. And the Japanese government has tried one stimulus program after another, in the process accumulating a national debt that, as a percent of GDP, is more than that of the U.S. Now the government -whose credit quality has already been downgraded by the big debt-rating companies-is considering bailing out the country’s ailing banks by buying the bad loans, packaging them into bonds how the U.S. securitization machine does this), and selling them on the global markets with some kind of government guarantee. And last but not least, the new Bank of Japan governor, Toshihiko Fukui, has suggested that he will, like the U.S. Fed, start buying longer-term Japanese bonds if necessary.

Japan also has a problem that’s the mirror image of the U.S. trade deficit. Because it runs a gargantuan trade surplus with the rest of the world, it has to manage a huge influx of dollars. It could simply let supply and demand work, which would result in the yen rising in value against the dollar. But that would hurt Japan’s exporters by making things priced in yen more expensive. And since exports are about the only thing that works for Japan right now, the country’s leaders are reluctant to let this happen. So the central bank has been buying dollars, thus accumulating a massive dollar-reserve position. To buy dollars they have to spend yen, which means they’re running their own printing presses ?at out.

So here we are. The world’s major economies are all living far beyond their means and are borrowing to cover the difference. And they will, it now seems certain, continue to create as much new ?at currency as it takes to delay the day of reckoning. The stage is set, in short, for a currency collapse a la Weimar Germany or 1990s Argentina, in which the world simply loses confidence in the dollar in particular and ?at currencies in general. In such a “flight from currency,” the demand for dollars will dry up. We’ll spend our cash the minute it comes in, sending prices through the roof (in dollar terms). We’ll shun financial instruments, including bonds and many stocks, like the plague. And we’ll return en masse to the only money that is impervious to government mismanagement: gold.


James Turk
for The Daily Reckoning
February 13, 2007

Editor’s Note: James Turk has specialized in international banking, finance and investments since graduating in 1969 from George Washington University with a B.A. degree in International Economics.

He is the author of two books and several monographs and articles on money and banking. He is the co-author of “The Coming Collapse of the Dollar” (Doubleday, December 2004).

In addition, James Turk is the Founder and Chairman of GoldMoney.com. Since 2001, thousands of individuals and companies have used GoldMoney® to buy gold to protect their wealth from today’s financial uncertainties. Many of them have also found GoldMoney’s patented process of digital gold currency payments to be an ideal payment solution for online commerce.

Learn more about GoldMoney®.

One of the great wonders of modern economic history is how Ireland transformed itself from the poorest country in Western Europe to the richest…in a space of barely 20 years.

It’s too bad, in a way.

It would have been nicer had Irish wealth come a little later – after architectural tastes had evolved a bit. We are, briefly, in Ireland this morning…and we see that billions of dollars worth of construction is being done – mostly in bad taste. The Irish will have to live with the buildings for many, many years. We doubt if future generations will be very grateful for the gift.

The housing industry seems to be filled with ingrates on the other side of the Atlantic, too. Look at the poor lenders in America. HSBC and Century Financial took a beating last week, when it was revealed that people who couldn’t afford their homes were not the best people to make mortgage loans to. Who would have guessed? The lenders have no reason to feel embarrassed, of course. They tried their best. They offered people the chance of homeownership. You really can’t do much more than that.

But the twits let them down. When it came time to pay back the money they had borrowed, the borrowers started hemming and hawing. ‘The check is in the mail,’ they said, drumming nervously with their fingers nails. ‘Can you wait till next month?’ they asked, sidling toward the exits. ‘Here are the keys,’ they offered, sneaking out of the door. How do you like that for gratitude?

And yesterday, ingratitude raised its head in the Middle East. It was another ‘Day of Death’ in Iraq yesterday, according to the BBC. Mayhem, bloodshed, bombings, murders…it is all playing on the nightly news near you.

What is the matter with those Iraqis? America spends all her money (and some she doesn’t have)…not to mention more than 3000 of her own soldiers’ lives…in order to give peace and freedom to Iraq. But those dumb Iraqis just can’t handle it. We have nothing to reproach ourselves with. We tried…we schlepped…we gave them the precious gift of democracy…voting…no-bid contracts… And look what has happened. They’ve made a mess of it.

Who would have thought?

More news…


Greg Guenthner, reporting from a snowy Baltimore:

“…It was a company announcement on January 25 that got the ball rolling. Overhill’s stock shot up more than 30% that day after the company inked a new deal with a new food label that would…”

For the rest of this story, and for more market insights, see today’s issue of The Sleuth


And more views…

*** We have been complaining for weeks that the markets have been becalmed in a Sargasso Sea of complacency. Well, yesterday, something stirred.

The lookout seems to have spotted an ominous movement near the horizon. From yesterday’s Financial Times comes this warning of stormy weather approaching:

“More than 22 percent of the 400-plus S&P 500 companies to have reported results for the fourth quarter of 2006 failed to meet Wall Street expectations. This is the highest level of ‘misses’ since the third quarter of 2004, according to Reuters Estimates.

“The spike in earnings disappointments increases the chances that corporate America will end a three-and-a-half year run of quarterly double-digit profit growth in the last quarter of 2006 rather than at the beginning of 2007, as widely expected.”

And from the Bureau of Economic Analysis comes a revision: GDP in the fourth quarter of 2006 was nowhere near 3.5% but much lower…closer to 2.5%. What a surprise! Spending and borrowing don’t make you grow wealthier!

Investors and speculators might still be complacent, but others aren’t. Insiders are bailing. Vickers Weekly Insider Report analyzes the insider reports that companies have to file with the SEC. Over the years, it’s computed that the long time ratio of insider selling to insider buying stays around 2.5:1. It’s bullish if the ratio falls below this level and bearish if it doesn’t. Over the last six months, the sell-to-buy ratio for insider transactions has been around 13 to 1, notes Vickers. That’s far higher than the long-term mean of 2.5 to 1, and it means that insiders are jittery.

But now, along comes an expert that says it ain’t necessarily so. University of Michigan finance professor, Nejat Seyhun, says insider selling isn’t always what it looks like. A number of factors make the raw data on selling unreliable as a guide to insider confidence. For one thing, a lot of the sales are of stock options, where only the sale on the open market gets recorded, making it look like there’s more selling going on than buying. For another thing, the numbers don’t tell us where the stock price might be heading. So the Professor has come up with his own Insider Confidence Index since 1975. According to it, confidence is just where it should be – neither hot nor cold.

Just the way Goldilocks likes it.

Here at the Daily Reckoning, headquarters, we literary economists like fairy tales too.

But we’ll keep our Crash Alert flag hoisted, thanks.

The Daily Reckoning