Why Trade Deficits DO Matter

Greg Canavan sent over an email recently:

Another month, another Aussie trade deficit.

Seriously, what does Australia have to do to generate a trade surplus? For August, the deficit was $815 million seasonally adjusted. For the past three months it’s totalled $2.7 billion. And that’s with very strong iron ore prices and volumes. When is this mining boom meant to pay off?

Luckily, the rest of the world doesn’t seem to care right now…

Greg never gives up. Whether it’s supporting the Blues in State of Origin or cheering on Aussie exports…

A trade deficit means we’re buying more from overseas than we sell. To make up for the difference, we must compensate elsewhere by increasing our debt, or selling assets outright. Thanks to years of persistent trade deficits, Australia is now paying around $35 billion per year to service the resultant debt.

To be honest, we don’t understand the point of having a national border, let alone national trade data. Why does it matter if an imaginary territory called Australia buys more goods and services than it sells? Nobody gets grumpy when the same happens between Queensland and Victoria, or the electorates Fairfax and Fisher.

We bet almost every household in Australia runs a trade deficit. It buys more goods and services than it sells, with expat workers heading ‘overseas’ every morning and repatriating their ‘foreign earnings’ to make up for the difference. Meanwhile, Aussie companies do the opposite, running chronic trade surpluses. But nobody laments the imbalance. In fact, it’s seen as a good way of structuring things, as long as the imbalances are within Australia.

That’s a very abstract point though. Most people think in terms of countries instead of individuals or households. In that case, the trade deficit is actually a symptom of instability in other areas. One example is the gap between savings and borrowings which too much consumption creates. An economy needs savings for the same reason a household does, to buy capital goods that improve productivity. Without savings, productivity stalls and an economy can only grow by increasing its population (or by borrowing more). Economic growth is overrated by many, but is incredibly important when you’re in debt.

That’s because you’ve got to repay your borrowings plus interest. If your economy shrinks and productivity stalls, that’s more difficult to do. So how you invest the borrowings is important too.

Cue the property debate, which rages on. Every commentator continues to focus on everything but debt. Stephen Kirchner explains in the Australian Financial Review how a lack of supply is the problem that leads to higher prices. And the Australian Bureau of Statistics reports August building approvals came up short on estimates.

Record house prices should lead to surging supply…in a free market. With the price of debt at a recent record low too, you’d think we have the perfect set up for a bubble. Restricted supply, cheap debt and a nation of house price speculators.

The question is which part of the bubble we’re in. The beginning, middle or end. On the one hand, prices are already outrageous. But interest rates are still on a downward path. We’re not an expert on zoning laws and the restrictions on construction. Let us know what’s holding back housing supply by emailing letters@marketsandmoney.com.au. According to some American academics, the difference between the US states that experienced a housing bubble and those that didn’t was zoning laws. Countries with restrictive ones had a boom and a bust because supply and demand weren’t allowed to reach an equilibrium.

Unfortunately, we can’t avoid the topic du jour. The latest on the sovereign debt crisis in the US…err we mean ‘the government shutdown‘…is that the nation’s bankers have been called in to fix things up.

Obama sent out the cry for help in an interview, saying that this time, Wall Street needs to be ‘concerned’ about the impasse. Shortly after, Goldman Sachs and JP Morgan sent their CEOs to the rescue. They explained to the media that, as bankers, they would have a sophisticated understanding of the consequences of a government debt default.

After all, both companies almost went bankrupt themselves recently. Who were they saved by again? Who dominates political donations to politicians in the US?

We expect that a lot of back scratching is going on behind the scenes.

Meanwhile, one of those ignored important events we mentioned is slowly taking place in plain sight. Our sister publication in the US, the 5 Minute Forecast, points out that foreigners are selling US government debt at a steady pace.

a
click to enlarge

And this is another place where trade deficits do matter. They create a lack of savings and funds at home. If your government is running a deficit too, somebody else needs to finance it. The less keen they are, the higher the interest rates they demand. If Americans begin to rely on their own savings to buy up their government’s debt, that’s going to bite into consumption.

For some reason, economists believe that when you save money it disappears from the economy. Keynes called it the Paradox of Savings. Of course, saved money doesn’t disappear, it is borrowed by someone else. It’s used to grow the economy. Especially if a business borrows the savings to finance a new machine that improves productivity.

But if those borrowings are used by the government, that’s not very likely to improve productivity. Which is why the US is in such a pickle. The government is soaking up the capital the country needs to recover.

And that’s where the Federal Reserve comes in. Oh boy, almost a whole Markets and Money without mentioning the Fed once!

Regards,

Nick Hubble+
for Markets and Money

Join Markets and Money on Google+

From the Archives…

The Fed Does the Reverse Volcker and Targets the US Unemployment Rate
27-09-2013 – Greg Canavan

How Much Juice can Australian Property Have Left?
26-09-2013 – Greg Canavan

Nothing Lasts Forever…Especially Easy Money
25-09-2013 – Chris Mayer

The Unintended Consequences Brewing Thanks to the Federal Reserve
24-09-2013 – Greg Canavan

The Market’s Declining Response To ‘Open Mouth’ Operations
23-09-2013 – Dan Denning

Download Your FREE Report:

The Aussie Recession Survival Guide: how to protect your wealth in a fast-shrining economy
Markets & Money Free ReportIn this urgent investor report, Markets and Money editor Vern Gowdie shows you why Australia is poised to fall into its first ‘official’ recession in 25 years…

You’ll learn:

  • What Central Bank Rate-Slashers Don’t Want You to Know: Has the Reserve Bank’s rate-slashing obsession really helped stimulate the Australian economy? Or has the incredible amount of ‘cheap money’ up for grabs simply dug a deeper economic hole? You’ll find out in Vern’s report…
  • Revealed: Australia’s 25 Year ‘Bulletproof Economy’ Fraud: Politicians have long talked up Australia’s apparent economic strength. You’ve been told we haven’t seen negative growth since 1991. But is Australia’s 25-year economic ‘golden run’ true? Has our economy really grown non-stop for a quarter century? You’ll be shocked by Vern’s findings…
  • Australian Government’s $1 Trillion ‘Black Hole’: The Aussie government ‘borrowing spree’ pushed foreign debt up $2 trillion in the last 15 years. Net debt (the money we owe foreign countries) stands at $1 trillion. What does this debt ‘black hole’ mean for the economy, your livelihood and the future of your family? Vern paints a bleak picture…

To download your free report ‘The Aussie Recession Survival Guide: How to protect your wealth in a fast-shrinking economy’ simply subscribe to Markets and Money for FREE today. Enter your email in the box below and click ‘Send My Free Report’.

We will collect and handle your personal information in accordance with our Privacy Policy.

You can cancel your subscription at any time.

Nick Hubble

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

Leave a Reply

Be the First to Comment!

Notify of
avatar
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@marketsandmoney.com.au