Thoughts On The Trade Gap

In January the U.S. trade gap widened to $58.3 billion. For all of 2004, the U.S. booked a record trade deficit of $617.1 billion, or 5.3 percent of gross domestic product. The trade gap with China widened by nearly $1 billion to $15.3 billion as exports plunged 20 percent. The trade gap with Canada widened to $6.2 billion, the most since June as imports grew by 4.3 percent.

Those that thought a falling dollar would cure this problem can look again. The US$ index is down about 40% since 2002 yet month after month the balance of trade just gets worse as evidenced by the following chart:

Following is a chart of the 3 month moving average of our trade deficit.
It is not a pretty picture.



The typical scapegoat for this sad state of affairs is China. That viewpoint is misguided and the following chart shows why. China accounted for only 15.2 Billion of that trade gap and given what is produced in China vs what is produced in the US there is no doubt in my mind that floating the RMB will not make one bit of difference. Is manufacturing going to return to the US with wages here 30 times what wages are in China? No chance!



At the Davos economic conference in January, the deputy governor of the People's Bank of China had this to say: "Outsiders don't know what exactly is happening in China. The idea that China has the key to the balance of the whole world's economy is totally wrong. The imbalances are attributable to many reasons, but not whether the yuan exchange rate is flexible or not flexible".

I would agree with that assessment. The problem is not China but the US. The US is in the midst of a "Crisis of Excess Liquidity". There is rampant housing speculation in housing and the stock market. People have treated their houses as ATMs and used cash out refis to leverage into more real estate and more consumption. This combined with lax credit standards and out and greed on behalf of sub-prime lenders together with cheap money from the FED is what is driving this frenzy.

I would have thought this situation to have been self correcting by now. I have been wrong. Manias last longer than even those that know the behavior of manias think. The problem is further compounced by Bush's proposed Social Security "reform". Smack in the face of horrid trade balances and US gov't budget deficits of approximately $400 billion, Bush wants to increase that deficit now to pay for a theoretical problem some 15-40 years down the road. The US treasury market is starting to revolt. If the Bush administration is not going to attempt even modest spending cuts, the bond market just might force the issue.

It will not be pretty and US consumers will bear the brunt of it. Historically, global imbalances such as the one we are in have only been corrected via recessions that wipe out previous mal-investments of capital. The upcoming recession will be a doozy as we have 20 years of reckless excesses to pay back.

Mish