Gold News

Gold & the trade deficit

Trade deficits don't have to be inflationary or boost the gold price...

HOW WILL YOU KNOW when the US trade deficit – built up with China – is starting to impact the value of the US Dollar...?

   My colleague, and editor of Big Gold, David Galland takes a look.

Doug Casey
Casey Research

A QUICK CHAT about trade deficits seems timely, starting with the notion that they are inflationary – right?

   Well, technically, trade deficits don't have to be inflationary. That's because, in the absence of government intervention, all a trade deficit should mean is that the people of one country are willing to trade their money for something on offer by the people of another country.

   In the 1800s, the US ran big deficits and did quite well because our country was full of opportunity and promise, so foreigners invested here, more than we invested there.

   The problem comes when a government, say China, steps into the picture and deliberately suppresses its currency to attract businesses to certain sectors of its economy – for instance, city dwellers. That causes an aberration, the result being a lot of US Dollars shipping out to China in exchange for all manner of consumer goods...Dollars that the Chinese have then turned around and invested in US Treasuries.

   More on that momentarily.

It's all political...and politics are fickle

   The massive deficits with China are unstable because, rather than being the result of open trade, they are based largely on political decisions made by a handful of people in the Chinese government.

   In time, those people – or their successors – may decide that there is more advantage to spending the Dollars. Or they will be forced to do it. Say, to appease other segments of the economy now penalized by the higher cost of foreign goods. Or they might have to spend the Dollars to pay the cost of a war or to bail the country out of a financial crisis.

   Regardless of the reason, at some point the political advantage of spending those Dollars, rather than hoarding them – which the Japanese did to their detriment in recent decades – will reach a tipping point after which those greenbacks will come flooding back to the market, devastating the value of the Dollar on foreign exchange markets.

   The Dollar has already, since 2002, lost about 26% of its value. Of course, a good deal of the pain that depreciation has caused to the wallets of non-US investors has been offset by the interest they earned on their Treasury bonds. But treading water is one thing, and standing by while your pile of cash starts to go up in the flames of a monetary crisis is another.

   Viewed from another angle, over time it isn't the trade deficit that is inflationary. Rather, the trade deficit is effectively a subsidy provided to the US by China...a subsidy that comes from the Chinese having used the river of Dollars provided by US consumers to buy the unbacked paper of the US government. That has allowed US interest rates to remain artificially low, forestalling inflation in the US.

   It is as if China is building up a big bank of inflation points. Sooner or later, they are going to spend those inflation points.

   Make no mistake, we are in uncharted water. It is unprecedented that the claims represented by the fiat currency of one government – that of the US – have been accumulated in such massive quantities for the reserves of other governments. And we're not just talking China, but virtually the whole world. And the world is getting nervous.

   To quote Thai Finance Minister Chalongphob Sussangkarn in his recent address to the annual meeting of the Asian Development Bank in Kyoto:

   "Should the financial markets lose confidence in the US Dollar, huge capital outflows from the US could lead to a rapid depreciation of the US Dollar, and thus dramatic appreciation of other currencies."

   The whole matter of trade deficits is, unfortunately for investors not paying attention, just one of far too many aerosol cans now roasting in the fire. When they start exploding, you'll want to be safely hiding behind a wall of gold and silver.

   In the final analysis, every day the Gold Price either goes up or the Gold Market goes down, with the movements based on any number of inputs. To avoid being panicked one way or the other, a long-term perspective is required to see these fluctuations in their proper perspective. And despite all the jagged fits and starts these past few years – and all the nay saying along the way – three years ago the Gold Price was around $393 an ounce...40% lower than it is today. The better gold shares have offered exponentially higher returns than that.

   While now is the time to begin accumulating your gold and gold share positions – if you have not already started Investing in Gold – how will you know when things are about to get really "interesting"? My partner Doug Casey recently made the observation that it is not when the trade deficit is rising that you should be concerned, but when it starts to contract...because that is a sign that the flood of greenbacks is starting to return home.

David Galland is the managing editor of Big Gold, a new publication from Casey Research dedicated to helping investors profit from the developing bull market in precious metals--with an easy-to-maintain portfolio of conservative mid- to large-cap gold producers and near-producers. You can learn about Big Gold and its six-month subscription refund offer here...

Doug Casey is a world-renowned investor and author, whose book Crisis Investing was #1 on the New York Times bestseller list for 29 consecutive weeks, a record at the time.

He has been a featured guest on hundreds of radio and TV shows, including David Letterman, Merv Griffin, Charlie Rose, Phil Donahue, Regis Philbin, NBC News, and CNN; and has been the topic of numerous features in periodicals such as Time, Forbes, People and the Washington Post.

His firm, Casey Research, LLC., publishes a variety of newsletters and web sites with a combined weekly audience in excess of 200,000, largely high net worth investors with an interest in resource development and international real estate.

See full archive of Doug Casey articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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