Investors Should Be Worried

President-elect Trump believes the US trade deficit has been responsible for the loss of manufacturing jobs in the United States and the downward pressure on US wages that has occurred over the last several decades. I share those views.

I have written about the harm the US trade deficit has done to the United States and about the destabilizing impact it has had on the global economy in all three of my books. Here are the opening lines from my first book, The Dollar Crisis:

"The principle flaw in the post-Bretton Woods international monetary system is its inability to prevent large-scale trade imbalances. The theme of The Dollar Crisis is that those imbalances have destabilized the global economy by creating a world-wide credit bubble."

Eliminating the US trade deficit is at the very core of the Trump Administration's economic plan. Unfortunately, unwinding this deficit without causing a global economic calamity may be impossible.

Over the past 35 years, the US Current Account deficit has become THE driver of global economic growth. It has flooded the world with more that US$10 trillion of US Dollar liquidity. The entire global economy has been constructed around that deficit. Eliminating it now could cause the economic superstructure of the world to collapse.

Here are my main concerns:

  1. If the US reduces its imports, the global economy will shrink. Whenever the United States imports less from the rest of the world, the rest of the world always imports less from the United States.
  2. If the US eliminates its $1 billion a day trade deficit with China, China's economy could collapse into a depression that would severely impact all of China's trading partners, and potentially lead to social instability within China and to military conflict between China, its neighbors and the United States.
  3. If the US Current Account deficit returns to balance, the global economy will suffer from insufficient Dollar liquidity, which could cause economic stagnation or worse.
  4. A reduction of imports from low wage countries would cause US inflation to rise, which would push up US interest rates.
  5. The elimination of the Current Account deficit would cause a sharp reduction in capital inflows into the US, which would also cause interest rates to rise.
  6. Higher interest rates would cause credit to contract and the US economy to go into recession.
  7. Higher interest rates would also cause a sharp fall in US asset prices. That, too, would cause the economy to go into recession.
  8. Higher interest rates could cause a wave of credit defaults in the US and around the world, potentially leading to a new systemic financial sector crisis.

Investors should be worried. Flaws in the post-Bretton Woods international monetary system have allowed a worldwide economic bubble to take shape and to reconfigure the structure of the global economy. Asset prices are stretched in the United States and all around the world. If the Trump Administration does implement policies that begin to eliminate the US trade deficit, interest rates are very likely to jump. In all probability, a brutal selloff in stocks, bonds and commodity prices would follow.

These risks are explained in greater detail in the first Macro Watch video of 2017, Trump's Trade Policies: Good Intentions, Devastating Consequences.

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