America's Other Deficit - More Borrowing Ahead

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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Everyone knows about the huge U.S. budget deficit and ever climbing national debt (now approaching $12 trillion), but much less attention is paid to the Trade Deficit. Both have multi-decade histories at this point. With the exception of the last four years of the Clinton administration, the U.S. has run budget deficits since 1970. There have been continual trade deficits since 1977. While the U.S. budget deficit hit a record high of $455 billion in fiscal year 2008, the Trade Deficit also hit a record by the end of the year and was even larger at $695.9 billion. Both deficits have to be paid for by borrowing, although the trade deficit has be funded by borrowing from foreign sources. This is how the budget deficit has been funded for many years as well, until the U.S. had to start resorting to out and out money printing in 2008. Few people realize though that the Trade Deficit can actually be a bigger drain on U.S. credit than the budget deficit is.

The reason for the current complacency is that the budget deficit soared in fiscal 2009, while the trade deficit is shrinking this year because of the after effects of the Credit Crisis on global trade. The U.S. trade deficit is now projected to come in at annual $366 billion for 2009. The budget deficit for fiscal 2009 (ending on September 30th) was $1.4 trillion. Next year's budget deficit is projected to be over $1 trillion as well. Whether the U.S. trade deficit has bottomed is dependent on the level of global trade and the price of oil. Oil is the key swing factor and if oil prices rise significantly they will overwhelm any benefits in rising exports from a falling U.S. dollar.

U.S. trade deficit figures for September was released on November 13th. The monthly deficit was $36.5 billion, almost $5 billion greater than analysts had expected. One media headline summed up the situation perfectly (a rare event for the mainstream financial press), "Trade deficit jumps more than expected in September as big rise in foreign oil swamps export gain". Rising prices led to oil imports going up 20.1% and imports overall 5.8% higher. Exports did indeed rise on the falling dollar, but were up only 2.9%. They were overwhelmed by the bigger import number thanks to oil.

While economic recovery means a potentially better U.S. budget deficit, it also means a worse U.S. trade deficit. Recovery outside the U.S., but a weak U.S. economy would be the worse of all worlds. Commodities are priced based on global demand and roaring economies in East Asia can drive the price of oil higher and higher. The U.S. trade deficit would rise and so would the budget deficit creating a self-feeding inflationary spiral. The Chinese economy is already much stronger the U.S. economy and yet the September U.S. trade deficit with China was $22.1 billion. China has managed to keep its exports high because it re-pegged its currency to the U.S. dollar in mid-2008 and this keeps the price of Chinese goods low in the West. It is generally believed the Chinese yuan is 40% undervalued because of the government doesn't let it float. While this undervaluation has allowed China to continue its high level of exports, there will be a price to pay down the road. Undervaluing currencies, just like excessively low interest rates and money printing, is inflationary. The market made this point clearly when the trade deficit news was released, gold shot up and the U.S. dollar sold off.

Disclosure: Long gold, no positions in the U.S. dollar

NEXT: Future U.S. Bailouts - FHA, FDIC, PBGC and U.S. States

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.