Tuesday, April 8, 2008 0 comments ++[ CLICK TO COMMENT ]++

What Will Stabilize the US$

One of the reasons the US$ must decline is because of the huge trade deficit. As long as the trade deficit is large, the US$ will be under pressure (as it has been for the last few years). I have always felt that the trade deficit was unsustainable and bound to shrink when the US economy slowed down. It looks like it is finally happening.

The following chart, courtesy Calculated Risk, seems to indicate that the US current account deficit has been flat for the last one and a half years:

(source: Calculated Risk)

The trade deficit excluding petroleum products has been rising sharply over the last year. The imports will continue to decline as the US economy slows. I have been bearish--and been wrong--on oil for over an year. I maintain my view that oil will start showing weakness once the economic slowdown is underway. Petroleum deficit will also likely stop growing once the US$ stabilizes somewhat. A lot of the run-up in oil prices during the last 6 months is due to the US$ decline.

The final action that is required for the current account deficit and the US$ to stabilize is for the US government fiscal deficit to be reduced. The US government deficit is also unsustainable in my eyes and will have to shrink. This isn't a matter of if but when.

Unfortunately, nothing is likely to happen on this front for years. Democrats, who, like most left-leaning parties, have always been viewed as fiscally irresponsible, are actually quite good balancing the books. It's quite interesting that the left-leaning parties such as the Democrats in the US or the Liberal Party in Canada have historically reduced spending more so than the Republicans (or the Conservative Party in Canada). They tend to do this, not by reducing spending necessarily but, by avoiding large tax cuts or discretionary spending on large wars. I think a Democrat win may result in a reduction in the fiscal deficit within the first term. However, it will be difficult for either party given the fairly large spending on Iraq. If Iraq spending increases, or if the bogus war on terrorism is expanded to Iran and other places, then it will be difficult to contain the fiscal spending regardless of who is in power.

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