Section 3. The Impacts of the Runaway U. S. Trade deficit (1): Who benefits? (Revised, February 12, 2013)

After revealing that the runaway U. S. trade deficit, the "Globalization Process of Yesterday" and currency manipulation plots form an inseparable triangle, the question why design such a system will naturally come up. The answer to this question will become clear by analyzing who will benefit from runaway U.S. trade deficits.

Politicians in power love the runaway U. S. trade deficit

Some time in 1980s when the U. S. trade deficit started to rise sharply as the Globalization Process had been pushed into the orbit, reporters asked a prominent economist about the trade deficit. The answer the reporters got was that trade deficit is like foreigners sending money to U. S. consumers, so why worry. The connotation of this statement is that foreigners are giving the money to U. S. consumers for free through the trade deficit. Of course, such an irresponsible statement is far from the truth. Let us see how the money flows when The U. S. runs trade deficits.

When The U. S. runs trade deficit, U. S. dollars flow into the hands of foreigners. Since Dollar is not the legal tender in foreign lands, those dollars must be brought back to U. S. markets to be lent out, naturally with interest. U. S. consumers then borrow those foreign owned dollars to buy more foreign made goods. The process just repeat itself. It is like a drunkard goes into a liquor store to buy $100 of liquor. The liquor store lends this $100 to the drunkard. The drunkard uses the borrowed money to buy more liquor. The process of buying liquor and borrowing from the liquor store just repeats itself. Such a ridiculous process cannot continue forever. Eventually the debt that the drunkard owes to the liquor store will become so large that the drunkard will not be able to pay back and be ruined financially. However, for a short while, the drunkard seems to have unlimited supply of liquor and becomes ecstatic. The situation of U. S. consumers is similar to the drunkard. They face long-term ruin, but in short term consumers are ecstatic since they have so much more goods to consume but with less hard work. Ecstatic consumers in turn make politicians in power very popular so they will be able to win reelections easily. That is why politicians in power love runaway trade deficits.

Runaway trade deficit makes Wall Street speculators very rich

Speculators thrive on leverage, that is, on borrowed money. To make this statement clear, let us consider the following example:

Suppose a speculator has one million dollars as the capital, and makes an annual gain of 10% in average, but use only his own capital for trades without any borrowing. This means that the annual gain of the speculator is $100,000. If the speculator wants to increase his gain, what should he do? One may say how about to boost the annual return to 20% instead of 10%. We should note that to have an average annual return of 20% is extremely difficult. Few speculators have the ability to score 20% return for many years. There is a much easier way to raise the gain of the speculator substantially. The answer is to increase leverage, that is, to borrow money as will be discussed below.

The speculator uses his one million dollar capital as collateral to borrow 5 million dollars, and trades on this borrowed 5 million dollars. If the speculator can make 10% return with 1 million dollars, certainly it is not difficult for him to make 10% return with 5 million dollars, too. Thus the annual gain from trades becomes $500,000. If the cost of borrowing that 5 million dollars is 5%, the net gain will be $250,000, 2.5 times of the gain if no money was borrowed. If the speculator can borrow 10 million dollars for trade, then the net gain after paying the interest will be $500,000 and so on.

So far we have discussed the case of a single speculator. If many speculators find a way to increase leverage by borrowing heavily. Wall Street as a whole will suddenly be able to put hands on a large sum of money. What are they going to do with the money? Apparently buy "something". Thus a bubble of "something" develops. If the money that Wall Street speculators can borrow floats in continuously, Wall Street speculators can borrow more and more, and the "something" bubble grows bigger and bigger. As the bubble grows, eventually non-speculative investors, driving by human greed, will be transformed into temporary speculators and will buy into this "something", too. Wall Street speculators will sell their "something" holding to those temporary speculators and make huge profits. When the bubble collapses, it is the temporary speculators that will be holding the bag. That is why we say that Wall Street speculators thrive on leverage.

With the fact that Wall Street speculators thrive on leverage explained, the next step is to demonstrate that the runaway U. S. trade deficit has allowed Wall Street speculators to increase leverage enormously. To do this we first review the situation before the era of the runaway U. S. trade deficit. Before the taking off of the runaway trade deficit, there were two major money pools. The first is the network of commercial banks. People and businesses deposit savings and idle cash into commercial banks so commercial banks held major portion of money circulating through the society at that time. Since the Great Depression, commercial banks had been regulated tightly. Wall Street speculators had hard time to borrow money from commercial banks to do speculation.

The major component of another pool of money outside of commercial banks is provided by insurance companies since they must invest collected insurance premiums. The liability of insurance companies are long-term, so their loans are mostly long-term ones. On the other hand Wall Street speculators are short-term oriented, and their favorite way to borrow is to sell short-term commercial paper. Due to this mismatch Wall Street speculators were not able to borrow big sums from insurance companies, too. The only place Wall Street speculators could have borrowed in the commercial paper market was the funds provided by cash rich businesses wanting to receive a little higher interest rate than bank CDs. Thus Wall Street speculators were starved of money, and were not able to increase leverage, so there were no big bubbles in the era between WWII and the start of runaway trade deficit. However, the runaway trade deficit has changed the picture and has allowed Wall Street speculators to borrow huge sum to blow gigantic bubbles.

As been said before, when U. S. runs trade deficits, dollars flow into the hands of foreigners. Then foreign governments and large foreign financial and business entities bring those trade-deficit generated dollar back to the U. S. markets to be lent out to highest bidders. Since those foreign dollars do not have long-term liabilities like insurance companies, huge amount of foreign owned dollars flow into the commercial paper market to be borrowed. By this way Wall Street speculators suddenly are able to borrow huge sums of money to increase their leverage, blow big bubbles, and leap huge profits. That is why Wall Street speculators love the runaway U. S. trade deficit.

Two special interest groups that love the runaway trade deficit as discussed here are certainly powerful enough to push the runaway trade deficit based Globalization Process into the orbit. We may even say that the Globalization Process of Yesterday is tailor-made for the benefit of those two special interest groups.




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