So Trump Wants to Reduce the Trade Deficit, Does He?

Yesterday I discussed Trump’s trade tariffs on steel and aluminium in the context of the global monetary system. That is, because the US dollar is the world’s reserve currency, it virtually guarantees large global trade imbalances.

Let’s explore this idea a little further today. And then we’ll see just how concerned the market is about a ‘trade war’ right now.

The first thing I should do is address the issue of ‘imbalances’. Although that word is bandied about quite a lot, it’s important to understand that everything actually balances out in the end.

When you understand this, you’ll be able to grasp how international economics work, without a post-grad degree.

Let’s take the US as an example. In 2017, it ran a trade deficit of US$566 billion with the rest of the world. It also earns net income from its investments located outside of the US. This inflow of capital offsets some of the outflow generated by the trade deficit.

Bringing the two together produces the ‘current account deficit’. For 2017, the current account deficit should come in around US$450 billion. (The current account data for the fourth quarter, and therefore for the whole year, is still a few weeks away from being released.)

So in effect, there was an outflow of US$450 billion last year. That means the US consumes US$450 billion worth of goods and services more than it produces. How does it make up the difference? It does so by selling off an equivalent amount of financial assets, usually in the form of bonds, stocks or land/property, to foreign investors.

In other words, the outflow of US dollars (the current account deficit) must be ‘balanced’ by an inflow of foreign capital (the capital account surplus). It doesn’t have to be an exact match. If there is a shortfall of foreign capital, for example, the US dollar will fall to attract what is needed to balance the accounts.

That’s why the US dollar often falls when the current account deficit is large. Roughly half a billion dollars is such a huge financing requirement that the dollar must fall to increase the purchasing power of foreign currencies, and therefore plug the financing gap.

A major deficit-financing tool is the issuance of US Treasuries. According to a recent Bloomberg article, foreign governments now hold US$6.35 trillion in US government debt, which is twice as much as 2008 levels.

Given Trump’s government is apparently on track for an US$800 billion federal deficit this year, he’ll need foreign governments to stump up a decent portion of that amount.

But if he gets his way and slashes the US trade deficit, there will be no spare change for foreigners to invest! 

Take the absurd example of the US running a balanced trade deficit. That is, no outflow of dollars. Consumption and production are equal. Also assume that the net income flowing from investments abroad remains in surplus. In other words, assume the US runs a current account surplus.

In such an environment, the greenback would soar, other countries’ export oriented industries would be decimated, and there would be a global credit contraction on an unprecedented scale.

Oh, and you’d see a depression worse than the 1930s.

Australia in particular would be cactus, because China would suffer the most from a US trade account in balance. It would pop China’s credit bubble, smash commodity prices (not to mention Aussie house prices), and leave us little more than a smouldering ruin.

Which is why the US won’t balance its trade anytime soon. Or ever. Not while the US dollar remains a reserve currency, anyway. And the US government won’t give up that sweet gig anytime soon. It’s the gift that keeps on giving. Imagine if you could pay for stuff with a printing press?

They just need to tell Trump about it. He doesn’t realise the debt he borrowed to build his property empire came courtesy of the US dollar standard. And he obviously doesn’t realise the debt he needs to borrow as President comes courtesy of that same standard.

It will be interesting to see how long Trump’s delusion persists.

Is there cause for concern for the global markets?

Right now, markets don’t appear as terrified as they could be. In a highly leveraged global economy, the threat of a trade war should be a big concern for the equity market.

So the muted response suggests investors don’t believe Trump is really that serious about improving the US trade imbalance.

I say muted response because the sell-off over the past week hasn’t really been out of the ordinary. The sharp bounce markets enjoyed over the past few weeks was always going to peter out. And I’m not just saying that with the benefit of hindsight.

On 21 February, I warned subscribers of my Crisis & Opportunity newsletter to prepare for more volatility. I wrote: ‘I think you should prepare for more volatility in the weeks ahead.’

See?

My point being that the market was going to turn down anyway. All it needed was an excuse. And cometh the hour, cometh the man: Trump upped the tariff rhetoric right on cue.

As you can see in the chart below, the second S&P 500 sell-off has been a little more orderly than the first. It doesn’t appear as if the trade war threats have been taken seriously. And overnight, the market rallied. It’s just not that concerned right now.

The second S&P 500 sell-off has been a little more orderly than the first.


Source: BigCharts
[Click to enlarge]

That may change. What you want to happen now is for the market to make a ‘higher low’. That would suggest it is merely consolidating its recent gains and gathering strength for another move higher.

If it doesn’t, there might be more to Trump’s trade rhetoric than currently meets the eye. And it might point to stocks entering bear market territory for the first time in years.

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.

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