Thursday, September 8, 2011

Trade, the real fool’s game

Trade, the real fool’s game

I would like to underline one aspect of the trade report that is not getting much attention- well ANY attention.

Although the deficit fell this month, at $44bln it can be annualized to a deficit of $528bln.

When we have a deficit in our trade account (more correctly, the current account) we obtain an equal amount of capital inflows to finance that deficit.

So here is the question:

So,why, when US banks have billions and billions of dollars in excess reserves, empowering them to make billions and billions of dollars in loans which they DO NOT MAKE are foreign investors pouring capital into the US at a pace of over $500 bln per year?

How do you reconcile that paradox?

We argue that there is no great attraction that 'pulls' foreign funds into the US. Instead we view capital flows as being 'pushed' by foreign investors who have other objectives.

That is we do not think that 'high US interest rates' are sucking capital in or that 'high rates of return in business investment' or in 'real estate' are attracting inflows.

We see the inflows as the result of foreign government's decisions to accumulate dollars in order to support the dollar at a relatively high level so they can pursue a policy of export led growth by keeping their currencies relatively weak and exports cheap.

These policies have caused the US current account deficit to persist. Developing countries have amassed the build-up of world foreign exchange reserves an action that can only be regarded as one that supports them in achieving their objective of keeping their respective currencies 'too cheap' and the currencies that they buy 'too strong'. Developing countries do not need FX reserves as much as they need to put those monies to work in their own countries to further their development. But they don't do that...

China's FX reserves rose 30% over the past year and stand at $3trillion. How does that accumulation not act to keep the yuan too weak and to perpetuate the US-with-China trade deficit? How else can it be interpreted?

By 2007 China had comprised over 30% of the annual US trade deficit and in 2009 and 2010 that percentage has moved up to 44%. Despite the US need to buy oil at high world prices China takes up 44% of the US global trade deficit.

A proper functioning exchange rate system would not keep a country's current account in a state of perpetual deficit. Yet, since 1971 the US current account has been in deficit for all by 24 quarters (24 out of 159; or 15%). The current account has averaged since 1971 a deficit that is 2.1% of GDP. The US has not seen a current account surplus since 1991Q2 a twenty year span. Currently, the current account deficit is 3% of GDP after reaching a peak percentage of 6.5% of GDP in in 2005. Interestingly the US had shrunk is current account deficit to 2.4% of GDP by the end of the recent recession, but in recovery even with GDP growth at 2.2% the current account deficit relative to GDP is rising again.

Since 1982 the US current account has been in surplus only two quarters. The ONLY progress in shrinking the deficit has come as the economy has slowed either just ahead of a recession or in a recession. For example from Q3 of 2006 to Q3 of 2007 when recession started, the US current account deficit shrank because GDP growth slipped below 2.5% and then the economy fell into outright recession. That caused the current account to shrink much faster. But it remains in deficit and a larger deficit than what has been normal. Since the last US current account surplus in 1991 the summation of the current account relative to GDP is 65%- no compounding.

Clearly this international monetary system is not working. It may not need to equilibrate the US current account immediately but we do need some signs of progress and improved fundamentals to support progress in that direction. The US current account deficit is huge and is hardly getting better; at 3% of GDP it is 50% above its average since 1971. Pumping the US economy full of debt is not helping. Even S&P can see the risk. The danger is that only debt saturation will stop this madness (bankruptcy). That is what happens if a well-functioning exchange rate system cannot be imposed on this dysfunctional process that perpetuates US debt accumulation (current account deficit). No wonder gold bugs are trying to push a gold standard. It would stop this madness, but would create and entirely new madness. Imagine moving to a gold stand and losing $500bln of gold reserves a year (the current account deficit). What sort of recession would you have to run to eradicate that and to stop losing gold? And with unemployment already at 9%?

Many economists reject this analysis and blame the US for its 'addiction' to debt but I see the US being force-fed debt because foreigners will not let the US mount any consistent export growth. In short the US does not enforce its exchange rate, on the markets. Markets do the ‘enforcing’ and right now markets are being manipulated by foreign governments. The foreign capital inflows (debt accumulation) by the US and the accumulation of massive foreign exchange reserves by foreign exporter countries far in excess of needs are the forensic evidence, the finger prints, of this ongoing currency manipulation.

The excess bank reserves are evidence that those flows are not being attracted by an insatiable US appetite for debt. We could slake that thirst at home with the banks.

If this were CSI I'd be ready to go to court.

Root of all evil (well, most of it anyway...)

In other words, this is not free trade. This is not fair trade. This is a fool's game and it is coming to an end one way or another. It is a process that is responsible for many other Ills in the economy that the fiscal deficit folk and the monetary mavens are trying to solve. It is at the root of our many and varied asset bubbles. But we are unlikely to fix either US fiscal policy or monetary policy until we deal with international monetary problem because it greatly exacerbates the other problems. Don't look for the G-7 to go there because no one seems to have a clue.

1 comment:


Its a fools game all right. Its a one way trip to china