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Generational Dynamics Web Log for 11-Mar-06
Trade deficit again worse than expected, reaches a fresh historic high

Web Log - March, 2006

Trade deficit again worse than expected, reaches a fresh historic high

Related: US Treasury bond prices fall dramatically on news from Japan

Imports and exports <font size=-2>(Source: Dept. of Commerce)</font>

Imports and exports (Source: Dept. of Commerce)

The above diagram from the Bureau of Economic Research press release tells the story:

Total January exports were $114.4 billion in January, up 3.5% from December.

Imports reached $182.9 billion, up 5.3% in December.

The difference, $68.5 billion, is the highest trade deficit in history.

Thus, the trade deficit continues to grow exponentially, despite the fact that, for years, economists, journalists and high-priced analysts have been predicting that the trade deficit would start leveling off because we have a "self-correcting" economy.

Economists had expected a $66.5 billion deficit. Brian Bethune, an economist at forecasting firm Global Insight told Bloomberg that the trade gap "is one of the symptoms of a U.S. economy growing faster than other countries."

I've seen these Global Insight guys quoted from time to time, and they always say such sugary nonsense they give the impression of airhead. This time, the exponentially growing account deficit supposedly means that the American economy is growing fast. By that logic, borrowing more and more and more on my credit card, letting my credit card debt grow exponentially, means that I'm a better and better worker. I don't see the connection. Do you?

What's happening is that other countries -- Japan, China, Europe -- have been purchasing US Treasury bonds in massive volumes. We use the money they give us to pay for our exports, to pay for our war in Iraq, to pay for Katrina benefits, and so forth. See? For those of you who are angry about all the money we're spending to fight the wars in Iraq and Afghanistan, don't worry about it -- China's paying for it, not us.

I'll admit that I didn't think this could go on as long as it has. I figured that China would begin to get fed up with this by now, but they're as addicted as we are. By giving us money in exchange for Treasury bonds, we buy Chinese exports, which lets them keep their own bubble economy going. It's incredibly bizarre.

But now, there's been a change in the last week.

One of the biggest mechanisms for this purchase of bonds has been the "carry trade." As I explained a few weeks ago, hedge fund investors have been borrowing Japanese yen at 0% interest, converting them to dollars, and lending the dollars to American investors at 4.5% interest or more. This has been going on for years, since the Japanese bank rate has been 0% for years.

But on Wednesday, the Bank of Japan announced that it's ending its "quantitative easing" that made huge amounts of money available (increased liquidity), and maintained zero interest rates. The policy was first instituted in 1999, when Japan was in a period of deflation.

As you read articles about the BOJ's announcement, you quickly learn that no one has any idea what's going to happen. One reason is that no one has any idea just how big the "carry trade" is, and how interlocked the carry trade investments are with one another. The danger is that the sudden loss of liquidity will cause one hedge fund to collapse, and that will cause a chain reaction that will bring down thousands of other hedge funds, one after another.

One thing that's already happens is a sharp fall in the demand for long-term US Treasury bonds. The high demand for these bonds had been so high that prices had been pushed up significantly, with the result that yields were down, lower than the yields on two-year treasury bonds. In anticipation of the Japanese move, demand for these bonds has fallen so much that yields have risen from 4.58% to 4.75% in the last month alone.

(Sorry about that last paragraph. Here's an explanation: A bond pays a fixed amount of money after 10 years or 2 years, respectively. The more money you have to pay to buy a bond, the lower the "yield" or interest rate you're going to earn. So prices of bonds go up as yields go down, and vice versa. Demand had been going up, so prices went up, and yields were low, at 4.58% a month ago. In the last month, demand has fallen so prices have fallen, and yields have risen to 4.75%.)

This sharp fall in demand for US Treasury bonds might level off, or it might the first sign of a more precipitous fall.

From the point of view of Generational Dynamics, we're headed for a financial crisis that could begin tomorrow, next week, next month or next year. The stock market today is still overpriced by a factor of over 220%, making it highly vulnerable to a panic. There's a housing bubble making homes as much as 100% overpriced in some regions. And there's a "carry trade" bubble of unknown size, except that it's known to be huge. If one of these bubbles bursts, then it will trigger bursting of the other bubbles as well, creating a worldwide 1930s style Great Depression. With the US trade deficit growing exponentially with no signs of stopping, the crisis will occur sooner rather than later. (11-Mar-06) Permanent Link
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Generational Dynamics Web Log for 11-Mar-06 Trade deficit again worse than expected, reaches a fresh historic high

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Generational Dynamics Web Log for 11-Mar-06
Trade deficit again worse than expected, reaches a fresh historic high