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Everyone knows the US has a growing trade deficit, the value of US imports being greater than US exports. Here are some monthly numbers:

$56.5 Billion. What analysts predicted for January ‘05, and feared might be exceeded.
$58.3 Billion. What the Commerce Department reported on Friday for January ‘05
$59.4 Billion. The record monthly deficit (11/04)
$66.1 Billion. What January’s deficit would have been at today’s oil prices.

Associated Press business writers explain the discomfort with a growing trade deficit. "The soaring trade deficit must be financed by foreigners willing to hold U.S. dollars in exchange for the products they sell to the United States. The concern has been that the trade deficit at some point could rise so far that foreigners become reluctant to hold dollar-denominated assets such as stocks and bonds."

"Such a development could send stock prices plunging and U.S. interest rates soaring. The mere prospect of such a change has been enough to send the dollar tumbling in recent weeks, following remarks by officials in South Korea and Japan that at some point they might consider holding less in dollar reserves."

This effect of the trade deficit is in addition to similar pressures caused by the US budget deficit. The amount each year that the US government spends over what it takes in is tantamount to printing money. This also has the effect of making dollars less valuable. It’s basic supply and demand; as more dollars start flooding the world, they become less valuable. Last year’s budget deficit was $427 billion ($609 B if you count money spent out of the Social Security “trust” fund, and there might have been a “supplemental” military expenditure not counted here). China bought about $200 billion in US Treasuries last year, which means they funded almost 50% of the reported US budget deficit.



Currencies are notorious for rapid losses in value when panic strikes; nobody wants to get left holding something of no value, like little green pieces of paper with the faces of former US presidents printed on them. Some people say, "The US is huge economy," implying it’s a safe bet that investors will stick with investments in the US. True, perhaps in the long run; however, if someone fears that a stock (or US currency) is over-valued (there is bubble), then they might sell the stock, wait for the bubble to pop, and buy the stock back later. It’s the old adage, “sell high, buy low.” Yes, in the long run, they are still investing in the stock (or the US Dollar), but they might take a little temporary break while the bubble breaks. It’s not quite this simple with US dollars, but the same principle applies.

So, were do people go when they don’t want to be holding dollars? Hard to say, but it appears they’re going to Euros and to gold. According to the Associated Press, "Gold closed in London at $445.90 bid per troy ounce, up from $440.80 on Thursday [3/11/05]." It closed New York at about $446. In early February, it was selling for $410, and was selling at about $260 in March 2001.



One brief note on the potential future of gold prices. There has been talk of the IMF selling gold. For instance, the Financial Times reported February 6 2005 "The International Monetary Fund is preparing a report on the potential sale of a portion of its gold reserves in a move that would help fund debt relief for poor countries but could unsettle the markets by threatening a drop in the price of gold." There is more to this IMF gold story, but we’ll save that for another day.

So what does all this mean? Sticking with the theme of this series of “Econ 101” articles, the message is that you have a better chance of being prepared if you see it coming. Those involved in the movement for deep social change should view a potential economic disruption as an opportunity. You can be sure that others are.
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