• Home
  • About
  • Team
  • Contacts
  • Blog

The trade deficit is not debt

  1. Home
  2. Blog
  3. The trade deficit is ...

Portfolio manager’s Letter November 2003

US trade deficit as a form of debt

Trade deficit

Recently there have been a number of stories in the financial press referring to the cumulative US trade deficit as a form of debt. I can understand that the average financial journalist managed to skip the part of his education that dealt with current account deficits and capital account surplus, but in September the economist featured a story about this countries trade deficit. “The Price of Profligacy” the sub-title was “how bad is American’s borrowing binge?” clearly indicates the author’s belief that the trade deficit creates debt, yet this conclusion is economic nonsense.

This Economist story is full of absurdities that make you wonder about the author’s ability to understand of his subject. There was a chart entitled “sinking into debt” that is actually graphical representation of American’s cumulative Capital Surplus. If you don’t understand the difference between debt and capital why are you writing for the Economist? There was another chart were the trade deficit is clearly labeled “net Foreign Debt”.

Our international Payments are always in balance, with any trade deficit and other Current Accounts offset by a surplus in the capital account. The Capital Account is made up of direct investments, equity and bond flows; and long term bank debt. If foreign investors are investing more money in this country than Americans are investing aboard then there is a capital account surplus.

But a Capital Account Surplus is not debt. While a portion of these investments may be in instruments of debt, no new debt is created; existing debt is just changing hands from a domestic investor to an international one. The transactions, even when bonds are involved, do not create debt. Does it make any difference to the issuer if it’s debt is held by a bank in Cincinnati or a bank in Rangoon? His interest expense has not changed in any way.

Cheap Capital

If the cumulative trade deficit is $2.5 billion as Warren Buffett says in his Fortune article, then that means foreign investors and residents of other countries who hold American currency, have provided this country with 2.5 billion in capital. If we look at the income accounts we find that this is pretty cheap capital. In 2002 America’s net payments on foreign investments was $4 billion (Interest and dividends paid minus interest and dividends received from our foreign investments). So the capital inflow to this country came at a cost of less than two tenths of one percent (.0016%). If you could get money at two tenths of a percent how much would you take?

Some of the above capital inflow has now turned into bubble food. How much is anyone’s guess, but it is possible that the world may not end up entirely satisfied with their bargain.

The World Wants Dollars

It has always been my view that trade deficit is more a refection of the worlds desire to hold dollars than it is anything else. The current account (trade and services) is in deficit because there is a Capital account surplus, not the other way around. The most important thing to understand about the US trade deficit is that it has nothing to do with trade policy. Should the American consumer complain because the third world wants to use dollars as part of their money supply, or because European investors want to buy the debt of the U. S. Treasury and of our large corporations?

But the driver of this truck is the Capital Account, not the current account. Does the institutional investor in Europe buy GE Debt because he knows there is some guy in Des Monies that wants to buy a Mercedes? I don’t think so. He buys the debt because he likes the return relative to the risk. The World does not buy American Assets because of a desire to subsidize the American consumer.

Foreign investors buy American stocks or bonds because they anticipate a decent return. The Capital Account Surplus is determined by foreign investors and their investment decisions. In making these decisions none of these investors gives a damn how much Americans are spending on Japanese SUV’s.

Offshore Currency

The Savers in the third world do not keep dollars in their wall safe because he wants to help Americans buy DVD players. He keeps dollars in the safe because he does not trust the local banks, and because his nation’s currency is constantly losing value to inflation.

Let’s say that you live in Russia or China or any of the other developing economies of the world were the banking system is unable to offer complete security to their depositors. In these countries you may use a bank for currency exchange transactions and to pay bills that you can not pay with cash, but your personal saving goes into the wall safe. This may be because you do not trust the neighborhood bank to be always solvent, or it may be because you do not want tax collector to know how much savings you have.

In any event, if you are stuffing your wall safe you want to stuff it with currency that will hold its value. So this means that as currency of different types comes into your hands you will spend the local currency but the Dollars, Euro, and Pounds go into the safe.

According to figures from the Federal Reserve there was $697 Billion of US currency in circulation in September 2003. No one knows exactly how much of this remains on-shore , but estimates are that at least 60% of our currency in circulation has left the country. 60% of $697 Billion is $418 Billion.

If this is correct then 17% of Warren Buffett’s estimated $2.5 billion of foreign investments are held in the form dollars in the wall safes in the third world. I fail to see how this U.S. currency held abroad represents any huge threat to our economy, and I doubt that much of it will return. Indeed it may well be an important part of the world money supply.

To the extent that this currency is part of the money supply of the third world, any overt attempt to reduce it, or repatriate it, would have a negative impact on the world economy. This currency is a U.S. asset that is held voluntarily by people outside of this country which costs us nothing, and may well be beneficial to the world as a whole.

History

If we accept the premise that the Capital Account drives the Trade Deficit then when we look at historical trends we are likely to draw different conclusions from Warren Buffett in his Article. The existence of a trade surplus (Capital Account deficit) for the years after World War II would be a reflection of the size of the American economy relative to the rest of the world. We had most of the capital and so there was not much international capital available to buy American Assets.

But as the world economy grew faster in the sixties and seventies other counties, such as Japan, acquired large amounts of capital. A lot of this was invested in American assets in the late Seventies because of very high interest rates in this country, and good prices for equity investments caused by a bear market.

Thought-out the eighties the world economy was growing rapidly and high American interest rates continued to feed the Capital Account Surplus. In the Nineties Japan experienced a high savings rate and very low interest rates. With much better returns available from American investments is it any wonder the Capital continued to flow in. It is also likely that the great stock bubble attracted a lot of foreign money.

As to the future I do not see that the current high level of foreign investment will lead to disaster. In general it seems likely the present trends will more or less continue. The American Capital Markets are the strongest in the world and don’t see a lot of competition in this Area. Certainly there will be mountains and valleys in the currency markets. The intermediate trend of the dollar will probably be down. The decline of the dollar will aggravate inflation in this country, and will eventually drive interest rates up and the stock market down.

But if foreign investors want to leave the American Markets entirely where are they going to go? Higher interest rates will eventually bring foreign investors back and the decline of the dollar and in stock prices will create values that will, at some point in the future, make American Assets attractive to foreign investors again.

11/01/2003



Leave a Reply Cancel Reply

Your email address will not be published.


Comment


Name

Email

Url


Blog Archive

2020

  • The Stock Market

2019

  • Behavioral Investing

2018

  • Trumped
  • Warren Buffett vs Wall Street
  • Globalism, 1982-2000 Bull Market

2017

  • Volatility Underlying Calm Market
  • What’s new with CB&I?
  • Passive Investing
  • Economic Cycles
  • Current Stock Market 2017 Comment

2016

  • Global Plastics Summit Highlights
  • Value Investing vs Index Investing
  • How to Play an Index Bubble
  • Successful Investors
  • Is the Market Overvalued?
  • Operating Earnings
  • Article by investment manager in Bay Hill Living
  • Building Foundation

2015

  • 3G Culture – Dream Big
  • Myopic Loss Aversion
  • CBI Nuclear Energy
  • St Joe Company
  • What’s in a Word? Plastics.
  • Are Bonds Safer Than Stocks?

2014

  • Chicago Bridge and Iron
  • CAMEX 2014
  • Global Economy October 2014
  • Fluor Corporation
  • Interesting Quotes from Daily Journal Annual Meeting
  • The Daily Journal Annual Meeting
  • Albemarle Corporation
  • Triumph Group
  • The American Energy Revolution
  • Singapore

2013

  • St Joe Company Update
  • Hedge Fund Managers
  • Triumph Group Inc.
  • Bitter Brew
  • An Antifragile Portfolio

2012

  • Leucadia National Corporation
  • This Time it is Different
  • Successful traders psychology
  • St Joe Company
  • Learning from Pain

2011

  • Long Cycles – Part II
  • Long Cycle
  • Nasty Month for Market
  • Make a Buck with Fortescue Metals Group
  • Berkshire Hathaway Look Through Earnings
  • St Joe Company Inc
  • Successful Investment Management
  • A Look Into Latin American Market
  • The Mother of all Quarters
  • 2010 Investment year results

2010

  • Fault Lines
  • US Market 2010
  • Berkshire Hathaway Third Quarter 2010
  • The Stock Market 2010
  • Berkshire Hathaway Second Quarter 2010
  • Berkshire Hathaway Performance
  • Long Term Greedy
  • Goldman Sachs
  • Berkadia and Leucadia
  • USG corporation
  • Berkshire Hathaway 2009 2010
  • Why Capitalism Works

2009

  • The Lords of Finance
  • The $44 Billion Dollar Train Set
  • Berkshire Hathaway 3rd Quarter 2009
  • Career Risk for Investment Manager
  • Berkshire Hathaway financial statements
  • Berkshire Hathaway Preferred Stock
  • Moral Hazard
  • Credit Default Swap
  • The Shadow Banking System
  • Learning Things the Hard Way
  • Our C-System
  • 2008 Investment results

2008

  • Investment Risk
  • Bear Markets
  • Generational Events
  • Orange sheets – Money is doing better
  • Inflation Not The Problem
  • Tipping Point
  • Long Term Capital Management
  • Financial Insurance
  • Western Refining Inc
  • Berkshire Hathaway Year To Date
  • Berkshire Hathaway Cash Flow
  • 2007 investment results

2007

  • Investment results 4th Quarter 2007
  • Greenspan on Inflation
  • Berkshire Hathaway Third Quarter 2007
  • Berkshire Hathaway Operating income 2007
  • Berkshire Hathaway Hedge Fund
  • Leveraged Buyouts
  • Stability Unstable
  • Weak Dollar
  • Berkshire Hathaway Chairman’s Letter
  • Steel Dynamics
  • Breakwater Resources
  • 2006 Investment year results

2006

  • New Investment Stocks
  • Equitas
  • Berkshire Hathaway Third Quarter 2006
  • Hurricane Synergy
  • Berkshire Hathaway Second Quarter 2006
  • Fat Pitch
  • Perfectly Obvious
  • Berkshire Hathaway Growth Rate
  • Berkshire Hathaway First Quarter 2006
  • Berkshire Hathaway Annual Report 2006
  • Inflation Is
  • 2005 Investment year results

2005

  • Exogenous Events
  • The Easy Money
  • Look-Through Earnings
  • High-Risk Mortgages
  • Unintended Consequences
  • Rydex Ursa Fund
  • Warren Buffett Premium
  • Private Equity
  • Latticework Mental Models
  • Buffett’s Lackluster Performance
  • 2004 Investment year results
  • Professor Smith’s Second Bubble

2004

  • Hedging Currency Disaster
  • Risk Assessment
  • Too Many Bears
  • The Chinese Century?
  • Patterned Irrationality
  • Timber
  • Costco’s Cash
  • Physics Envy by Charlie Munger
  • Asset Allocation Berkshire Hathaway
  • The Balance of Payments
  • 2003 Investment year results

2003

  • Hedge Funds
  • The trade deficit is not debt
  • Secular Bear Market
  • Which Index Funds?
  • A Different Drummer
  • Costco’s Float
  • The Power of Float
  • Berkshire Hathaway Annual Meeting 2003
  • Psychology of Human Misjudgment
  • Sitting on the Sidelines
  • Berkshire Hathaway intrinsic value
  • 2002 Investment year results

2002

  • Insurance company Moats
  • Bond Bubble
  • Berkshire Hathaway Cash Flow 2002
  • Behavioral Economics
  • The Bear Market 2002
  • Greenspan Put
  • Second Quarter Cash Flow at Berkshire Hathaway
  • Berkshire Hathaway Annual Meeting 2002
  • Red Wire – Green Wire
  • Stupid FED Tricks
  • The Bottom Line
  • 2001 Investment year results

2001

  • Don’t Fight the FED
  • Buy and Hold? – It all Depends
  • Ben Laden and Berkshire Hathaway
  • The Dinosaurs Dance
  • Costco Moat
  • Bubble Watching
  • Sit on your Ass investing
  • Berkshire Hathaway Annual Meeting 2001
  • Carnival Cruise Lines
  • 450000 Square Ft Furniture Store
  • Lunch Money Indicators – Annual report
  • Other People’s Money

2000

  • Bear Tracks
  • Build It and Money Will Come
  • Efficient Stock Market
  • Style Drift
  • Lunch Money Indicators – Options
  • Identifying Problems
  • Small Retail Stocks
  • Charlie Munger comments
  • Big Al and the Bubble Machine
  • Berkshire Hathaway Cheap
  • Index Funds
  • 16 rules for investment success
Make an appointment or contact us by phone: +1 (689) 246 49 49
© 1999 - 2022 Losch Management Company
Support by Global AGM