Why the U.S. Trade Deficit is Worsening and Dollar Implications

By: Eric_deCarbonnel

Right up until the commodity bubble burst this summer, there was the ridiculous theory going around that the world was now "decoupled" and that European and emerging markets would somehow avoid being affected by the US slowdown. These decoupling theories disappeared as oil dropped like a rock, only to be replaced by an equally ridiculous idea: that the world's economic pain would be spread evenly. This is wrong. Although the entire world is going into a recession as a result of the credit crisis, some economies are better prepared than others to weather the storm.

Durable and capital goods

The US's manufacturing sector is concentrated in industries most vulnerable to an economic downturn, durable and capital goods. Durable goods are products that last for more than three years like SUVs, motor/sail boats, etc. These items are the first areas where consumers cut back spending, which is why the big three are in so much trouble. Capital goods are equipment/machinery used in creating other goods, and the biggest demand for these products has come from emerging markets with their growing manufacturing sectors. With emerging market manufacturing now in contraction, demand for these capital goods is set to disappear, which leaves the US in a disastrous situation:

• We make mining equipment at a time when commodity prices are crashing and mines are shutting down.
• We make construction equipment (caterpillars, pickup trucks, etc…) at a time when global construction is grinding to a halt.
• We make civilian aircrafts at a time when global trade and travel is quickly contracting.

Cheap consumer goods

At the other end of the spectrum from durable and capital goods are the cheap consumer goods found in retailers like Wal-mart. Demand for these lower-end consumer products tends to hold through the severest of recessions, because they are absolutely essential to our modern standard of living. While some current shoppers at Wal-Mart might be forced to cut spending on these essential items, new spending from shoppers who are downgrading from higher end stores will pick up a lot of this shortfall. For example, as more American's lose their jobs, there will be a lot of consumers downgrading from designer clothes to Wal-Mart's cheaper clothing. The resiliency of Wal-Mart sale is bad news for the US, as virtually all the retailer's cheap goods are imports from Asia.

The trade deficit

A quick look at where the US's trade deficit is concentrated reveals just how grim the outlook is. We are running huge deficits in consumer goods and industrial supplies (oil), which we desperately need, and the only category with a sizable surplus is capital goods (civilian aircrafts, mining equipment, etc), for which global demand is crashing. This explains why the US trade deficit grew in October.

Implications for the dollar

While imports to the US are falling, US exports are falling even faster. Exporting nations still have to finance our massive trade deficit, but are now getting less benefits from it. If this trend continues and the US economy keeps shrinking, Asian nations will abandoning their dollar pegs and start focusing on stimulating domestic demand instead. The dollar will quickly lose all its value when this happens.

By Eric deCarbonnel
http://www.marketskeptics.com

Eric is the Editor of Market Skeptics

© 2008 Copyright Eric deCarbonnel - All Rights Reserved
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