America’s Other Big Deficit – More Borrowing Ahead Everyone knows about the huge U.S. budget deficit and ever-climbing national debt (over $12 trillion at the end of 2009), but much less attention is paid to the Trade Deficit. Both deficits have multi-decade histories. With the exception of the last four years of the Clinton administration, the U.S. has run budget deficits since 1970. There have been continual trade deficits since 1977. While the U.S. budget deficit hit a record high of $455 billion in fiscal year 2008, the Trade Deficit also hit a record by the end of that year and was even larger at $695.9 billion. Both deficits have to be paid for by borrowing, although the trade deficit has to be funded by borrowing from foreign sources. This is how the budget deficit has been funded for many years as well, until the U.S. had to start resorting to money printing in 2008. Few people realize though that the Trade Deficit can actually be a bigger drain on U.S. credit than the budget deficit. The reason for the current complacency is that the budget deficit soared in fiscal 2009, while the trade deficit shrunk because of the after effects of the Credit Crisis on global trade. The U.S. trade deficit is now estimated to come in at around $380 billion for 2009. The budget deficit for fiscal 2009 (ending on September 30th) was $1.4 trillion. In its mid-session review in August, congress estimated a $1.5 trillion budget deficit in 2010. Whether the U.S. trade deficit has bottomed is dependent on the level of global trade and the price of oil. Oil is the key swing factor and if oil prices rise significantly, they will overwhelm any benefits in rising exports from a falling U.S. dollar (note that a falling dollar causes oil prices to rise). On the flip side, a rising dollar will also expand the trade deficit by making U.S. exports more expensive and less competitive. The U.S. trade deficit for September was $35.7 billion. This was $4 billion greater than analysts had expected. On the day of the release, one media headline summed up the situation perfectly (a rare event for the mainstream financial press), "Trade deficit jumps more than expected in September as big rise in foreign oil swamps export gain". Rising prices led to oil imports climbing 20.1% and imports overall being 5.8% higher. Exports did indeed rise on the falling dollar, but were only up by 2.9%, not nearly enough to compensate for the increase in oil imports. According to government figures, oil imports then dropped 10.6% in October. As would be expected, the trade deficit fell. It was 7.8% lower than in September. While economic recovery means a potentially better U.S. budget deficit, it also means a worse U.S. trade deficit. Recovery outside the U.S., but a weak U.S. economy would be the worse of all worlds. Commodities are priced based on global demand and roaring economies in east and south Asia can drive the price of oil, metals and agricultural products higher and higher. Under this scenario, the U.S. trade deficit would rise and so would the budget deficit creating a self-feeding inflationary spiral. The Chinese economy is already much stronger the U.S. economy and the September U.S. trade deficit with China was $22.1 billion. China has managed to keep its exports high because it re-pegged its currency to the U.S. dollar in mid-2008 and this keeps the price of Chinese goods low in the West. It is generally believed the Chinese yuan is 40% undervalued because the government doesn't let it float. While this under valuation has allowed China to continue its high level of exports, there will be a price to pay down the road. Keeping a currency at artificially low levels, just like excessively low interest rates and money printing, is inflationary. A realistically valued Chinese currency, would lower the U.S trade deficit, but transfer the inflation more immediately to the U.S. Like the U.S. budget deficit, there are a number of approaches that would lower the trade deficit. All have serious negative consequences however and this is why the trade deficit will remain until some crisis point is hit. Foreign lenders will eventually no longer wish to or be able to fund it. As it has done with the budget deficit, the U.S. government will almost certainly resort to printing money and this will cause the dollar to devalue at an even faster rate and make the problem worse.   Daryl Montgomery Organizer, New York Investing Meetup http://investing.meetup.com/21