Why The Dollar Hasn't Collapsed Amidst The Trade Deficit

International trade narrowed ever so slightly for the month of June. Let's just call it basically flat. We're a long way away from the trades deficit being in positive territory, or from reversing the trend.

The plain fact of the matter is, we are a service related economy... no scratch that... a finance related economy, and it's cheaper for us to buy goods from overseas, while simultaneously being the world's financial and banking center. Investors from all over the world have been continually rushing into our financial markets. And for that, we are stuck buying their cheap wares:

If you think about it in those terms, these people are getting one helluva deal.

And that's why the dollar doesn't collapse (nor will it) every time we buy something from overseas. The businesses on the other end are accumulating the cash they receive from us and investing it right here in our markets.

Is that a good idea? You betcha.

Think about it: What does China produce? Cheap t-shirts. Inexpensive, low-tech wares that we gobble up at prices far lower than we would not be able to compete with because our economic standards of living are far higher than these countries.

What do we produce? Think high-tech. Just look at the products produced by the biggest high-tech companies out there.... Microsoft... yeah, I said that. And of course Apple. And every other company out there that produces a product well beyond the basic necessities of mankind.

If you were to value one widget produced by one American worker, it could be valued in the hundreds or even thousands of dollars. If you were to value one widget produced by one worker over in these regions, it might be worth only $1.25. Who would you rather invest in?

It's the trade deal of a lifetime.

Now you know why the dollar hasn't collapsed because we are buying products from overseas. It won't happen. And you can tell any other pundit out there that keeps saying the trade deficit is going to be the death knell for the U.S. to start thinking outside the tiny box they live in.

Comments

[VennData:]

I a worker produces 1,000 widget A in an hour that have revenue - at $1.25 apiece - that's $1,250 of revenue. If this American worker makes a $1,000 widget B in an hour, the $1.25er is more productive.

If the margin on Widget A is a bit more and/or the invested capital is a bit less, than the profit is also much more on widget A. Successful economies run on return on invested capital and productivity.

China grows quickly because they can obtain great returns on capital, furthermore, Huawei is an example of a Chinese firm that produces telecom equipment that looks like widget B's above.

So this widget argument is misplaced and simplistic. Comparative advantage is a better way to look at the distinctions between particular widgets produced by particular countries.

There are reasons the dollar hasn't dropped further: Higher relative interest rates, the reserve currency status in a dollar-based global trading system that grows faster than total world GDP, etc.

But the dollar has dropped and is in a bear trend since the year 2000. The future may see the dollar rise or fall. Just remember that Japan had the low margin lending market cornered during the late eighties with the top seven or eight of ten banks in the world financing "assets" all over the world.

What are banks and the repackaged markets of the US finance is housing. This may turn out to be very un-productive investments. When our house-price-dependent "financing" system feels the pain of all of those homes that do not provide a return, our finance-based system will show its true colors.

2006 Aug 10 12:26 PM

[WC Whiner:]

While on your prediction for the dollar's future course we can respectfully disagree, on your factual assertions I am afraid you're just wrong. Basing your investment theses on counterfactuals can work (viz going long internet in the late '90s), but only if you get lucky.

To enumerate just a few of your hits:
+ foreigners are getting "one helluva deal"
- the US return on FDI dwarfs that to foreigners
+ "you betcha" that's a good idea
- borrowing high and lending low is a bad idea
+ China produces cheap t-shirts
- I don't have the heart to quote the data to you

I gave you one star, and I fear that may have been generous. No, scratch that: your long-dollar posture is working today. "WOrking today" is always worth one star, no matter how perplexing the rationale underlying the trade.

2006 Aug 10 12:56 PM

[The Kennel:]

> The plain fact of the matter is, we are a service related economy...and it's cheaper for us to buy goods
> from overseas, while simultaneously being the world's financial and banking center. Investors from all over
> the world have been continually rushing into our financial markets.... And that's why the dollar doesn't
> collapse (nor will it) every time we buy something from overseas. The businesses on the other end are
> accumulating the cash they receive from us and investing it right here in our markets.... If you were to
> value one widget produced by one American worker, it could be valued in the hundreds or even thousands
> of dollars. If you were to value one widget produced by one worker over in these regions, it might be
> worth only $1.25. Who would you rather invest in?

Let's see if I have this right: the dollar won't collapse despite the trade deficit (not to mention the budget deficit and the savings deficit) because investing in the USA is so attractive. And investing in the USA is so attractive because we make expensive widgets.

You are so far off base on this that I suspect you are having us on and your essay is an attempt at ironic humor. But on the off chance you are serious, then it would be helpful if you would take note of the following:

[a] The largest buildout in human history is happening right now in Asia.
[b] Generally, the best investment opportunities are where the growth is.
[c] The negative savings rate (deficit) in the USA - which exists because of our reknowned appetite for foreign widgets - constrains us to rely on foreign "investment", much of which is used to fund our interest payments on the budget deficit and thus is not a genuine capital investment.
[d] We attract these investments by offering interest rates that compete with the organic ROI generated by high growth in China and India; these in turn engender a need for more foreign "investment"...can you say, "ponzi scheme"?
[e] The ability of the Fed to maintain high interest rates is tempered by the danger of throwing the domestic economy - spearheaded by the interest-rate-sensitiv... real estate market - into recession, which would inhibit our ability to continue to consume foreign widgets and degrade the value of our real estate and equity markets, and thus make us less useful.
[f] To the extent that they accrue dollars, US government debt, and investments in USA real estate and equity markets, these foreigners are themselves at risk of a dollar collapse/USA recession, and thus have an interest in propping us up.
[g] Right now, the emerging Asian economies need the irrational USA consumption engine to fuel their growth, but they are rapidly building their own consuming middle class (who, btw, are already largely capable of producing expensive widgets and providing expensive services, and whose prowess re:same improves every week).
[h] Eventually, the Asian economies will generate enough consumers to be self-sustaining, at which point we will be superfluous, and the risks of accrueing greenbacks/USA "investments" will outweigh the benefits. Those who lacked the foresight to exchange their dollars for yuan (or gold, or pennies - *already* worth 1.4 cents each - or razor blades) will be needing wheelbarrels to trundle enough cash to the grocery store for the weekly shopping trip.
[i] The dollar is *already* in decline: in 1976, you could buy 10 barrels of oil for an ounce of gold or one barrel for $11...in 2006, you can buy nine barrels of oil for an ounce of gold, or one barrel for $72.

So, if you were just kidding, congrats; you got a rise out of me. But if you were serious, and stubbornly are going to eschew laying in a supply of razor blades, I recommend you practice growing a beard, because once all your dollars collapse, you won't be able to afford to shave.


Brad Hessel
Manager, The Kennel

2006 Aug 11 10:53 AM

[REBEL:]

For Intelligent Investors;
The above article is simplistic to the max and here are three reasons of many why the dollar will collapse: 1) China and India are producing
high-tech goods and displacing our companies: e.g. computers, pharmaceuticals. But this is little compared to what the Chinese autos will do to the domestic auto industry; "How about a full-size sedan with all the bells and whistles for UNDER $10 Grand?" 2)The dollar is a Reserve currency because the rest of the world still accepts it. Therefore they must buy from us to support our currency
so their dollars do not collapse and they lose billions. 3) The dollar has collapsed 80% since 1971 - enough said!

2006 Aug 14 10:27 PM

[Ames Tiedeman:]

The U.S. Trade Deficit is a huge problem. We will either end up being owned by foreigners or we will simply fade away. Both prospects are quite un-American. Some basic facts: The U.S. has not had a trade surplus with the world since 1974. We have not had a trade surplus with Japan since April of 1976. We stopped having trade surpluses with Eurpoe in 1983. Fifteen years ago we did not have a trade deficit with China. Now we have a 250 Billion a year deficit with the People’s Republic. A nation that does not make anything is a worthless nation. Worse, the longer we go without making the needed investments in our manufacturing infrastructure, the more knowledge we lose. We will either forget how to manufacture or we will simply not be good at it. Our creative energy fades away if we do not use it. Also, it is innate to want to make things. Kids play in sand boxes, youg men build tree forts. This is human nature. All of this is being taken away from the American people by idiots in Washington who do not know how to make trade deals.

2008 Apr 27 11:24 PM