Ever since the French “no??? vote, the world’s attention has been diverted away from the high-wire act taking place in America, to the side-show happening in Europe. However, with Luxemburg’s “yes??? vote on the EU constitution over the weekend (indicating that the European dominos have stopped falling) and today’s release of a yet another $55 billion plus monthly trade deficit, the spotlight has refocused on what is surely the main event. Traders and investors, speculators of all ages, may I call your attention to the 8th Wonder of the World, America’s gargantuan trade imbalance!
While May’s trade deficit was not as horrific as some had feared, the sheer size of the number provides a potent reminder of the enormity of the imbalance. Whatever problems Europe may have in terms of unemployment and slow growth, they pale in comparison to the U.S.’s monster imbalances. The dollar’s sharp two day decline in anticipation of today’s report, partially reversed by a relief rally today, provides potent evidence that the value of the dollar will be largely determined by trade performance. And there should be little room for optimism on that front.
Last week’s employment report revealed that while 146,000 Americans found jobs in June, 24,000 fewer workers were actually employed making things for them to buy. The result will be even larger future trade deficits, as newly employed Americans spend their paychecks on imported products. Further, the continued expansion of the housing bubble and abundant access to cheep credit means American homeowners can continue converting paper appreciation into real purchasing power. Since there is no actual increase in domestic production, new demand can only be satisfied though imports. In addition, the renewed surge in crude oil prices will exert additional upward pressure on the trade deficit.
As quickly as it appeared, the recent dollar rally will likely fade into obscurity. Nothing more than a small blip in the “mother of all bear markets.??? Many novice traders misinterpreted recent euro weakness for legitimate dollar strength, and placed foolish wagers on the buck. These bad bets will ultimately be covered. Still others foolishly concluded that the dollar’s ability to rally in the face of rising current account and trade deficits proved that such imbalances do not matter. In fact, bullish dollar sentiment, which became so extreme so quickly, is likely a harbinger of a sharp dollar decline to come. Keep your eyes on the center ring, and your savings out of dollars.