Benson's Economic & Market Trends Building a Record Trade Deficit Isn't Easy Richard Benson Nov 17, 2003 The dollar has begun its long downward adjustment and, for a few months, it looked like the US Trade Deficit might have peaked. In September and October the service part of the economy began to generate jobs, but the manufacturing sector is still losing employment. As the economic recovery takes hold, the pattern of job creation in services, not manufacturing, is likely to continue. For a while it seemed like the Bush Administration would have to do more than talk about the trade deficit and take some kind of action, with all those jobs going to Asia. In this election year, job creation and rising incomes must be achieved at all costs. However, since the US only produces 45% of manufactured goods here, there is a lot of room for spending and cash to leak abroad. With less political pressure on job loss, there is no reason for multi-national companies to change their steady and profitable course of closing American factories and moving production overseas. Creating an all time record Trade Deficit is not easy! If a country like Argentina tried to run sustained trade and federal deficits of 5%, and commit national economic suicide, they couldn't do it because no other country would finance them! The US is special - we own the world reserve currency. If the US wants to ruin our currency, credit, and economy in an orgy of consumption, our major economic competitors are more than willing to assist. Some of the world's richest and strongest countries have much to gain by giving America a shot at racking up all time record trade and budget deficits financed solely with other people's money. The US Trade Deficit could go up to $600 billion a year, or 6% of GDP. Thank God America still has the world reserve currency to debauch! Our trading partners should remain fully accommodative for our need to finance an even greater deficit. Such a policy is in their short and long term interests, not America's. Asian Central Banks run their printing presses to create liquidity to buy ample supplies of US Treasury and GSE mortgage debt, while US consumers keep Asian factories humming while new factories are being built at a furious rate. From a distance, the average American only sees odd symptoms from the liquidity driven Asian boom, as we send them our money. Because of the shipping trade imbalance, enough containers have piled up on American shores to build Pyramids that would dwarf those in Egypt, and dry cargo rates, to ship raw materials to China, have hit record highs. Indeed, Asia might spend more of their dollars if ships were available to bring in what they want. Asia is printing up and spending about $500 billion a year in fresh Central Bank currency and it is creating quite an inflationary economic boom on the other side of the Pacific. As part of the process, Asian Central Banks are building up a "war chest" of dollar assets that mirror the decline of US manufacturing, and a staggering number of empty shipping containers stacked up on shore. Indeed, America now owes the rest of the world $3 Trillion, and the large Asian Central Banks of Japan, China, and South Korea, hold about $1 Trillion of US Treasury and other dollar assets. It looks like they will accommodate the Bush Administration and make it a $1.5 Trillion holding by the election. The question building for the investment community is "what is the price of the loan?" As China's economic power grows, they may even start acting like Americans by dictating to others or simply taking what they want. Perhaps they will begin spending the Trillions of US dollars we have given them - but what will they want to buy first? Japan makes better cars than America, so they don't need cars from us. There are even items, such as consumer electronics, that we don't even make in America at all. The last time anyone saw an American made TV was in a junk yard. In fact, virtually any manufactured good can be made as well, and for less money, in Asia. Asians might like Hollywood movies or our computer software, but, for now, they can copy the best for free (In the future, software engineering jobs are moving there as well). It is amazing what 3 billion bright hard working people are capable of doing. When you really get down to it, there is little that Asian countries need from the US other than our manufacturing jobs, our markets for the goods they produce, and the means to buy the raw materials to run their factories. As long as we continue sending our jobs and money, and the dollar remains the word reserve currency, they will play this game. Indeed, given the political realities and economic interest of the parties involved, the current trade deficits and Asian purchases of Treasury bonds is likely to continue well into 2004. A new factor in the balance of world trade and power is that China is on the verge of replacing Japan as the #2 importer of oil, after the United States. The impact on the world for economics and poser of this fact should not be underestimated. Already, China is competing with Japan over who will be favored for the new Russian oil pipeline. Japan is struggling with the US about investing in oil in Iran, and Iran is clearly using Germany, France and the olive branch of inspections and access to oil to balance US power in the Gulf. Oil and other strategic resources are what major powers compete and fight for. Competition over resources is truly on the horizon! In the not so distant future, the massive inflation that Asia has been building by monetizing US trade and federal deficits will be coming back to America. These massive holdings of US dollar assets are going to get spent. The Chinese are going to want something for their money. Asian car production is increasing. China needs lots of oil and every other raw material that can be imagined. We have given our "Foreign Friends" enough money to buy up an incredible share of the world's resources. The problem for America is that when Asia starts to spend their dollar currency reserves, they are not going to spend much on American products and services; we just don't have the resources they value. However, as the dollars get spent, it will push up the price in dollars of all basic goods and raw materials that all developed countries need. Holdings of US Treasury Bonds and Agency securities will be sold but the nagging question is, "to whom will they sell?" Right now, the Asians are the buyers! It's likely that US inflation and interest rates will rise and bond prices will crash. If the Federal Reserve steps in and starts to monetize, the Fed would have to print up at least $500 billion of fresh cash a year and make the ultimate inflation even worse. America's problem is we only know how to buy prosperity by spending other people's money. When foreigners start to spend their dollar assets, it will be hard to imagine who will be available to finance the US Trade and Federal Deficit. The average American has been conditioned to spend, not save, and asking Americans to save now would be too much of a shock, especially before the election. There is a simple rule to remember with respect to the dollar and our economy: As the Trade Deficit gets bigger and we go farther and farther into national debt, it's inevitable that the dollar will continue to fall, inflation will rise, interest rates will also rise, and a crash in financial asset prices could occur. If America can set a new record Trade Deficit now before the election, we can surely set a new record drop in the dollar after the election. Sadly, for those Americans who believe that the government's policy of "Party Now and Pay Piper Later" is the way to go, they may discover when the time comes to pay the bills, they'll have nothing left to pay with. Richard Benson November 17, 2003 President Specialty Finance Group, LLC Member NASD/SIPC 2505 S. Ocean Boulevard - Suite 212 Palm Beach, Florida 33480 1 800-860-2907 eMail: rbenson@sfgroup.org ______________ 321gold Inc ref: 01214