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January 12, 2005

Why the World Loves America's Deficits
by Richard Benson

At the end of last year, the nation's financial deficit - what the United States owes the rest of the world, minus what the rest of the world owes the United States - amounted to more than $3 trillion, and it's still growing. This account deficit means the United States imports more than it exports. To fill the gap - and its budget deficit - it borrows heavily. However, while the trade deficit weakens the dollar, it strengthens the world! For Europe, Japan, China, and even America, as long as the nation's trade and budget deficits continue to grow and are financed by the world's central banks, everyone seems to win! Let me explain.

Let's take The European Central Bank "ECB" as an example. The ECB is the central bank for Europe's single currency, the euro. Their main task is to maintain the purchasing power of the euro and thus price stability in the euro area. The euro area comprises the 12 European Union countries that have introduced the euro since 1999. The ECB needs to be able to "place their paper" at a reasonable cost when they borrow, the same way any corporation that borrows would have to do. Given the fact that Germany and France are having a horrendous time keeping their budget deficits below three percent, and Greece is regularly "cooking their books" and running six percent budget deficits, you would wonder who in their right mind would be interested in putting their cash in sovereign euro debt.

The current account deficits - the broad gap between exports and imports of goods and services - are mushrooming out of control so much so that on a relative basis, they almost make the euro look good on an absolute basis. In 1999 when the euro was introduced, there was great fear that it might fall apart. Sure, the Europeans hate the weak dollar and the fact that the Americans and Chinese are competing with unfairly low prices. But for now, making the euro a rival to the dollar as a world reserve currency is more important! As the euro is being firmly established, European countries and businesses can borrow at subsidized rates because of the pressure to get out of the dollar. Inflation in Europe is also lower and oil is relatively inexpensive. Euro pride can run high!

Another example is The Bank of Japan's buying of limitless amounts of United States' treasury and agency securities. This has allowed Japan to run their printing press much faster than they could otherwise without suffering embarrassment. Japan's budget deficit is approximately seven percent, which makes the United States look fiscally responsible in comparison! In 2005, Japan will have about $240 billion worth of fresh Yen bonds to sell to finance their government deficit but very few people will want to buy them with interest rates there at almost zero. When Japan is buying dollars to hold down the Yen, no one thinks twice about the extra monetization. What's more important, is the fact that as long as the world thinks there is money to be made from dumping the dollar against the Yen, speculators and gullible investors will buy the hundreds of billions in new government debt Japan has to place. (In reality, Japanese fiscal policy remains bankrupt.) In addition, Japan gets to build up massive dollar credits it can use in the future so it can continue to attack and destroy industries, such as the American Auto Industry (GM just announced another seven percent cut in U.S. jobs). Of course, the Japanese would like to keep their foreign exchange reserves safe, but funding their deficits and getting American jobs is more of a priority.

The story on China is similar to Japan, only more so. In 2004, speculating investors invested over $95 billion in China. This cash is in addition to China's $150 billion trade surplus last year and the massive $610 billion in foreign currency reserves they have amassed. China is running the fastest industrialization effort in the history of the world using classical "mercantilist trade policies". A greatly undervalued Yuan is pegged to the dollar. These speculating investors may never get a return on their money, much less a return of their money, but they are confident they can't lose as the Yuan will have to revalue against the dollar. Don't hold your breath. (Obviously, these investors have never read history; even recent history!)

China has been winning the economic war against America as our factories are closed down and relocated there. Just like the Japanese, China would like to keep their foreign exchange reserves safe. However, for now, with the dollar going down against the euro and the Chinese Yuan fixed to the dollar, the Chinese government can begin their "big push to collapse and replace European industry" after helping to reduce American production to a meager 45 percent of our nation's consumption. China has recently witnessed worker riots, so getting Western jobs remain the number one priority just to keep a lid on the domestic, political situation.

Clearly, one of the most important things for the Bush Administration to focus on is getting foreign central banks to finance a major portion of our budget and trade deficits. In the first nine months of 2004, foreign central banks purchased $315 billion of our financial assets. This is equivalent to about three-quarters of the U.S. trade deficit, and more than enough to pay for the war in Iraq. Temporarily, this central bank buying of dollar assets holds down our interest rates and keeps our economy in a housing boom, with false prosperity and no savings. Our government seems to have decided that as long as our country is the military superpower, the strategy of exporting troops to the Middle East and jobs to Asia - in exchange for a lock on the oil reserves and cheap imports - remains more important than rebuilding American industry.

So for now, all the major countries seem to "win" (as their central banks print up new money to finance our trade deficit) because (i) the euro is secure; (ii) Japan can finance a seven percent deficit; (iii) China gets everyone's jobs; (iv) America gets its war paid for; (v) every major country gets financed, and (vi) all the produced goods get sold with that last $600 billion bought by Americans on credit.

Perhaps things will change as inflation bursts out into the open and exposes the fraud of prosperity through printing money. Or, at some point, central banks may discover that not only do they need to finance new U.S. debt being created but all the old debt as well, as the private sector dumps their dollars en masse. This would surely put into question the seemingly limitless dollar asset buying spree of the world's central banks.

For the future, however, Bush's wish list, led by the privatization of Social Security and a reform of the tax code, seems to leave little space for policies that would reduce our country's deficits. Greenspan, himself, in a speech to German bankers recently warned that "foreigners would probably demand higher interest rates and bond yields to hold American debt". The real question may be "when does the debt become so big that foreigners begin to worry about getting their money back with a reasonable return?" With America taking the short-term economic view, and Asia taking the long-term economic view, the future will prove very interesting.

The losers in all this will surely be those who want to save in dollars, insist on holding investments denominated in dollars, and Americans who would simply like a job working in the most efficient and productive factories in the world, rather than sit back and watch them be built, with the latest technology, half a world away. Unfortunately, since most Americans will continue to use dollars, you can guess who's going to be the big losers here - just look in the mirror!

Richard Benson
Benson's Economic & Market Trends
Specialty Finance Group, LLC

Prior to founding the Specialty Finance Group in 1989, Mr. Benson acted as a trading desk economist for Chase Manhattan Bank in the early 1980's and started in the securitization business in 1983 at Bear Stearns, and helped build the early securitization businesses at Citibank and E.F. Hutton.

Mr. Benson graduated from the University of Wisconsin in 1970 in the Honors Program in Math, and did his doctoral work in Economics at Harvard University. Mr. Benson is a member of the Harvard Club of New York and Palm Beach.

The Specialty Finance Group, LLC is a Florida Limited Liability Company and is registered with the NASD/SIPC as a Broker/Dealer.

Copyright © 2004-2008 Richard Benson

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