Thursday, March 09, 2006

Another Month Another Record Deficit

The US trade deficit for the month of January 2006 did not disappoint. It was another record deficit of over $68 billion, that is over $2 billion a day. If this rate is to persist for the rest of the year, and it is expected to, then 2006 will record a trade deficit of around $800 billion. As a result many in the Congress have escalated their attacks on the Bush administration for its liberal trade policies and are threatening to introduce measures that will insulate the American economy. It should be clear that these protectionist measures will not address the major cause for the deficit but will merely politicize the issue without delivering any relief, if relief is needed.

Trade deficit, in a free market economy is not set by the government but is a direct outcome of consumer behaviour. Just under 70 % of the trade deficit for the month of January is accounted for by only two items. Imported oil bill totaled $24.6 billion during the month of January 2006 while the total value of the imported automotive goods added another staggering $22.7 billion. I am sure you will agree that Washington did not actively promote the sales of either Lexus or Honda neither did it encourage the purchases of Mercedes or BMW for that matter. I am equally confident that very few would approve of any efforts by the government to dictate the brand of vehicles that is to be purchased.

The goal of eliminating the trade deficit in the foreseeable future is as unrealistic as the goal of "Energy Independence" and just as misguided. If a country, any country, cannot afford its level of imports then the value of its currency will plummet, foreigners will cease to provide it with credit and its domestic producers will become more competitive. These adjustments will continue until a working balance is restored to the supply and demand of its currency on the foreign exchange market.

So, in light of the above, what does the evidence show? Surprisingly enough, the US dollar has not moved much against the euro one way or the other. When the Euro was launched on January 1, 2002 its exchange rate was $1.17= 1Euro, currently the rate is $1.22=1Euro. The same is practically true of the Japanese Yen which was trading around $=120 Yens in early 2002 and is currently exchanging hands at about $1=118 Yens. So what gives? Most of the excess US dollars supplied on the world markets as a result of the American consumers current fascination with things imported have been recycled back to the US through the equity markets. Foreign investors have shown a voracious appetite for US corporate securities and have thus been more than satisfied to supply us with the variety of wines, cloths,cars and energy in exchange for an equity position in various US corporate enterprises.

In the final analysis international trade is nothing else but a process of exchange. And when that process is not inhibited by governmental rules and regulations then the parties to the exchange will agree to it only if they deem it to be mutually beneficial. In the case at hand, the US pays for its net imports through exporting equity positions to the rest of the world. If we decide that it is not in our interest to sell major US based operations to nonresident enterprises then we must reduce our level of imports from the rest of the world. It is as simple as that.

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