Golden Profits from the Chinese Trade Deficit

By: David Galland | Mon, Jul 23, 2007
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The Casey Files

A quick chat about trade deficits seems timely. Starting with the notion that they are inflationary, right?

Well, technically, they don't have to be. 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 U.S. 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 U.S. dollars shipping out to China in exchange for all manner of consumer goods... dollars that the Chinese have then turned around and invested in U.S. 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 foreigners has been offset by the interest they earned on their Treasuries. 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 U.S. by China ... a subsidy that comes from the Chinese having used the river of dollars provided by U.S. consumers to buy the unbacked paper of the U.S. government. That has allowed U.S. interest rates to remain artificially low and forestalled inflation in the U.S. 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 U.S. -- have been accumulated in such massive quantities for the reserves of other governments. And we're not just talking China but virtually the 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 U.S. dollar, huge capital outflows from the U.S. could lead to a rapid depreciation of the U.S. 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 gold goes up and gold 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, gold was trading for $393 an ounce... 40% lower than it is today.

And 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 doing so -- 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

Author: David Galland

David Galland
Managing Director
Casey Research, LLC.

David Galland

Over the course of his varied career, which includes a stint at the fabled Climax mine following college, David Galland has worked as a conference director for the world's largest investment conference (National Committee for Monetary Reform, 1979 to 1987), as a financial newsletter publisher or editor (Gold Newsletter, the Aden Analysis, Wealth Magazine, Outstanding Investments, among others), as a founding partner and director of a successful mutual fund group (Blanchard Group of Mutual Funds), and as a founding partner and executive vice-president for EverBank, one of the biggest recent successes in online financial services.

David is currently a partner with Doug Casey and Olivier Garret in Casey Research, LLC., an international firm providing research and investment recommendations to individuals in over 150 countries. Casey Research currently publishes several publications on a variety of investment sectors, including metals & mining, energy, technology and commodities. In addition to his management responsibilities, David serves as the managing editor for The Casey Report, a monthly publication dedicated to identifying big trend moves and how to profit from them; he also writes a daily communique, Casey's Daily Dispatch.

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