by Jennifer Barry
September 15, 2005
In July, I wrote about the United States' growing current account deficit, largely driven by the huge trade deficit with Asia. To balance our national "checkbook," enough foreign capital must flow into America to offset the trade deficit. These purchases of assets and debt primarily consist of Treasury securities, and are noted in the TIC report. If the net inflows of capital don't match or exceed the trade deficit, the dollar could drop and bond yields could skyrocket. After two consecutive months of negative reports, the trend has reversed, and we have now seen two months of capital inflows higher than the U.S. trade deficit.
Unfortunately, the latest TIC has some ominous undertones. Foreign purchases of Treasuries dropped to their lowest level since September 2003, and private overseas investors actually sold 3.3 billion more Treasury Bonds and Notes than they bought. The divestment of Treasuries was compensated for by a huge surge in hedge fund purchases of corporate bonds, a result not likely to repeat. Hedge funds invest aggressively, and are quick to dump a position if it's not profitable. Even U.S. citizens bought $146 billion in foreign assets in the past year, the highest amount since 1994.
The $478 billion trade deficit this year to date has other implications. As Warren Buffett pointed out in his annual letter to shareholders, America is rapidly transferring its wealth to foreigners in exchange for cheap goods. In 1980 America became a debtor nation, and overseas investors now own over $3 TRILLION NET of U.S. assets. In fact, America is practicing a sort of "reverse mercantilism" where we facilitate imports, neglect exports, and encourage foreign banks to accumulate huge dollar reserves.
Some U.S. policymakers believe that a gradual decline in the dollar will stimulate American exports. However, the 28% drop since 2002 hasn't even slowed the trade deficit. Chinese manufacturing workers earn less than $1 per hour, while Americans make nearly 20 times that amount. Even if China revalued its currency by 30%, U.S. laborers still wouldn't be competitive.
In addition, decades of outsourcing have devastated the American manufacturing base. If U.S. goods were cheap by global standards, what would we sell? Most of our heavy industry is now located overseas.
As I look around my office, I find very few items still made in this country.
Although Americans send billions of dollars a year overseas, they are still shocked when foreigners try to spend their piles of green paper by purchasing U.S. companies. Dollars have no intrinsic value; they are worth only what you can exchange them for. If countries can't spend them, why should they accept them at all? The falling value of the dollar has made many nations nervous as they watch the purchasing power of their currency reserves draining away. Countries such as Russia have started swapping their depreciating dollars for euros and gold.
China in particular has been shrewdly acquiring natural resources and hard assets with their fiat money. It's not surprising that their government was angered by American political resistance to their bid for Unocal. China has spent a huge portion of its dollar reserves on U.S. Treasuries to finance American debts. However, they have sated their demand for expensive, low-yielding bonds, and wish to diversify their portfolio.
As Warren Buffett has pointed out, foreign ownership of U.S. companies "is an inevitable consequence of what we are doing in trade." Despite President Bush's "Ownership Society" initiative, Buffett has stated that America is heading towards a "Sharecropper's Society." If the U.S. doesn't make some radical changes, the future will involve sending a growing percentage of American GDP to its creditors "simply as tribute for the overindulgences of the past."
While you can't reverse the trade deficit single-handedly, you can avoid becoming a "sharecropper." First, reduce your debt levels and increase your savings. Americans had a negative savings rate in July for only the second time in 46 years, so break from the mainstream. You need a cushion in case you lose your job, or a natural disaster strikes.
Second, buy local products when you can, and conserve one of our biggest foreign imports, oil and gas. Fuel isn't going to get cheaper anytime soon. Consider downsizing your house and car to save on energy, not to mention interest payments.
Third, protect yourself against the depreciation of the dollar by diversifying into hard assets like precious metals. Of course, you will need some cash for daily expenses, but invest your savings in tangible goods whose gains have outpaced inflation. Barry Bannister, Jim Rogers, and others have concluded that we are in a bull market for commodities, so you can't use the same investment strategies that were successful during the tech boom of the 1990s. Buy commodities today, and stop sending so much of your wealth to foreign owners.
© 2005 Jennifer Barry