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.

Probable Future Outlook for the United States

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Guest Blogger: Trevor Gauntlett from 'Running the Gauntlett'

What concerns me most is looking at the highly probable future outlook for the U.S. …

The government is taking over Freddie and Fannie, which will help out new, but not existing home buyers. By assuming responsibility for their debt, the gov’t is using inflation adjusted tax dollars to keep these companies operating . However, a $500 billion dollar short fall is projected this year in the budget and the U.S. national debt is already at about 9.7 trillion and growing ever so rapidly. If we tack on unfunded liabilities, we are talking anywhere from 50-70 trillion in obligations. Effectively the government is insolvent. Now what happens when government revenues begin to decline due to the slowing economy, baby boomers start to take money out of social security and access Medicare when they retire, and the continuation of the Iraq war / Afghan war / maybe Iran war?

I’m failing to see the light at the end of the tunnel.

During the housing boom, U.S. consumers purchased houses because money was cheap. Everyone felt rich so they purchased more consumables for immediate gratification. These weren't investments with productive value that would add to the economy in the future and they experienced immediate depreciation. Once U.S. consumers could no longer get money out of their homes through refinancings and HELOCs (home equity lines of credit), we started using our credit cards. Look at who is producing and who is consuming… we in the USA are primarily guilty of the latter and it is all funded through the rest of the world’s savings. At some point other countries are going to refuse to continue supporting the U.S. spending binge - this might already be taking place.

As for housing it will have to come back down to reasonable values. If we encounter a period of hyperinflation then housing could be a good asset to hold onto (although this was not the case during the hyperinflation in Wiemar Germany in the early 1920s). On the other hand, if we have a depression I could argue the opposite.

People are already losing their HELOCs because banks are worried that consumers won’t be able to afford them. Legal or not this is happening. I also heard from a Real Estate agent in Seattle that banks are asking for 25% down on new mortgages. In an earnings call in late January 2008, Bank of America executives said credit card delinquencies in California, Florida, Arizona, and Nevada—states with high foreclosure rates—increased five times as fast as in other states, suggesting that consumers struggling with their mortgage debt are also finding their credit card bills hard to pay. “We’re focused on getting paid for the risk we take,” said Joe Price, chief financial officer. - US News and World report 2/28/2008.

What happens if the United States dollar loses its status as the reserve currency? Then everyone with dollars will flood the market to get rid of them. The dollar is a commodity just like gold and silver, but unlike gold and silver any amount of it can easily be created. It has no intrinsic value and is a exchangeable commodity and legal tender because of government fiat (hence paper money is fiat money or fiat currency). If people want dollars, the price rises and as people desire them less, the price falls. Loss of reserve currency status would mean the demand for U.S. dollars would fall significantly. Why would anyone want dollars when you look at the future for the US economy except because of necessity or political reasons?

The GSE bailout will help to prolong the issues that the financial industry is facing. The United States government will do everything in its power to support the system through money creation and taxation, giving individuals and institutions more time to pull their money out of the dollar. An immediate collapse would make that very difficult and costly.

I’m getting the sense that things could get a whole lot worse than any of us imagine.

NEXT: The Banks and Brokers Most Likely to Fail - The Big Players

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.