The Big Problem with the Global Economy

The latest news to worry investors is the prospect of a trade war. Markets took a turn for the worse last week following Trump’s decision to impose tariffs on steel and aluminium imports into the US.

The only surprise is that the response wasn’t much worse. Especially given Trump’s bizarre ‘war by tweet’ on Friday, as reported by the Financial Times:

In a series of Friday morning tweets, Mr Trump declared “trade wars are good” and “easy to win” as he vowed to fulfil his campaign promises to defend US workers and industry from what he has long portrayed as unfair foreign competition.’

Trade wars are good?

Let’s see how that works out…

I don’t know much about global trade, who’s cheating, who’s not, and what the actual ‘rules’ are. I doubt if many do know. It’s a horribly complex topic.

But I wouldn’t be surprised if Trump is justified in imposing tariffs and criticising the EU for putting up its own barriers. From the Financial Times, again:

Donald Trump has fired back at EU threats to retaliate against his planned tariffs on imports of aluminium and steel, declaring he would simply target European automakers if that happened.

“If the EU wants to further increase their already massive tariffs and barriers on US companies doing business there, we will simply apply a Tax on their Cars which freely pour into the US,” the US president tweeted on Saturday. “They make it impossible for our cars (and more) to sell there. Big trade imbalance!”

The big problem here is that the post-Second World War global economy isn’t really designed for balanced global trade. It was for a little while. But as the US began to consume more than it produced in the 1960s, gold started leaving Fort Knox to balance the tab.

There wasn’t enough gold at the prevailing fixed price (US$35 an ounce) to balance the tab. So Nixon ‘closed the gold window’ to stop the Europeans (in particular, France) from swapping excess greenbacks for real money.

Ever since, the US has continued to consume more than it produces. This year, it’s on track to generate a trade deficit of more than US$500 billion. That’s US$500 billion of excess dollars of dubious long term value accruing to the surplus producers of Europe and China, and Japan.

This trade deficit/surplus didn’t just appear overnight. It’s a structural result of the US dollar being the world’s reserve currency. That is, in the early stages of a nations’ economic development, accumulating US dollars is a priority.

The ‘reserve’ dollars form the basis for the financial and banking system to develop. It provides foreign investors with confidence.

The only way to accumulate dollars is to run a trade surplus with the US. That’s what Europe and Japan did after the Second World War. It’s what China did following its entry into the global economic system in 2002. 

The global trading conundrum

There is a problem with that though. In order to accumulate dollars, the economy grows around a dependency on exports. And part of this dependency is probably breaking trade rules when it suits. Like shipping excess stock to large and open markets like the US.

Before you know it, the dependency is structural. That is, it’s just the way it is, and everyone gets on with it. And the US has been quite happy with this development. Who wouldn’t be? If you could buy whatever you wanted, and pay for it via your own personal printing press, you’d be chuffed too.

That is, until you realise that some important industries aren’t as strong as they once were. And that if you keep resorting to the printing press, those industries will eventually die out. And then, one day your trade partners might realise the dollars you keep sending them aren’t really worth the metal that they’re sending you. Then you’re screwed.

I very much doubt that Trump has thought things through that far. After all, he thinks trade wars are good, which suggests he’s not really thinking at all.

His moves to impose tariffs should — but probably won’t — start a wider conversation about the nature of global trade. That is, that it is hugely imbalanced and prone to dislocation.

The underlying problem that free and fair global trade faces is the US dollar as the world’s reserve currency. While ever this ‘standard’ remains, the world will face periodic crises.

Whether Trump’s latest move is the start of another ‘crisis’ remains to be seen. As always, the stock market will give us clues as to what’s unfolding before the mainstream news does. More on that tomorrow…

Greg Canavan,
Editor, Crisis & Opportunity


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing. He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’. That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors. And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis. Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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