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[ThatHawaiiGuy]

The US Trade Deficit and "Phony" Deflation
Richard Benson
September 11, 2003

The Federal Reserve, under the current administration, is permitting the US money supply to "rip" by artificially holding short term interest rates well below the rate of official CPI. The US is running 5% budget deficits, Euro land 4%, and Japan 8% ­ these government deficits are larger than savings which means that without the creation of highly inflationary new money and credit, there would be absolutely "no growth!"

China is printing new money at a 20% rate and Japan has vowed to not let its currency appreciate, even if it has to print enough new money to buy every US bond and note the US Treasury needs to finance our $500 billion budget deficit.

The Fed Chairman has made it his current quest to fight "deflation." Given the massive printing effort of the world's central banks, the efforts to fight deflation are beyond cynical. What's really going on?

Obviously, Asia doesn't want to "trade" on a level playing field and they want to force their currencies "down" and continue to help the American Consumer spend more than they earn. They will finance our Federal and Trade deficits, as long as we help them build the latest and most efficient factories and ship our jobs to the other side of the Pacific. By letting Asia hold their currencies down by 30% - 50% below the "free market rate," in the US it appears we are importing deflation, while China, Japan and the rest of Asia, accumulates a massive hoard of US Dollar reserves.

With Asian currencies artificially held down, to the US it would appear like we are importing deflation. Meanwhile, Asia and the rest of the world are reflating and printing money like crazy. At first blush, this deflation is a paradox - in reality, the deflation is both phony and temporary. However, the phony deflation is extraordinarily convenient and gives Greenspan a cover to keep short term US interest rates depressed and money growth high. The moment the US dollar and Asian currencies are allowed to "float" and seek the level that brings trade back into balance, the prices of Asian goods, causing deflation, will soar. Import prices will go to normal and we will see a tremendous amount of "missing inflation" ­ the phony deflation will vanish and the deflation paradox will be over. This will not be a good day for Alan Greenspan and interest rates.

At present, inflation in services is running at a 3.5% - 4% rate and the only reason that inflation looks tame is because manufactured import prices are artificially held at 30% to 50% below where they should be and holding the core CPI down. Can you imagine what will happen to interest rates when the dollar sinks, and the CPI is seen to really be rising at 4% to 5%?

Not only are Asians eager to take work from lazy Americans and Mexicans who don't want to work for $10 a day, but they are delighted to become America's biggest creditors. At present, the United States, through its rising trade deficits, has built up debts abroad of over $3 Trillion dollars, and we are adding to the total at a rate of $500 billion a year. Asia has been willing to finance America's consumption orgy and federal deficits because they are building up massive currency reserves, held primarily in US Dollar assets. Being a banker to the world's super power that controls Mid-East oil, looks like it is in Japan's and China's short term interests. China and Japan need oil and other commodities and building up dollar reserves that the world will take in payment for now is almost as good as building up strategic reserves of these commodities which will be essential to running their industrial complex.

The reason our beloved Fed Chairman is so cynical in selling us on "deflation," is that not only will there be an inflationary shock from the Dollar going down against our trading partners, but at some point those massive dollar reserves building up overseas are going to be exchanged for something of value; something real. Not only will a sharp drop in the dollar cause a sudden "Pop" in inflation, but when foreigners want to swap their dollars for something real, there will be another surge of inflation. The Fed Chairman knows this and talk of deflation is a delaying tactic hoping to postpone the dollar crash until a new Administration and Fed Chairman can get all the credit for creating far too much money and credit.

Indeed, the "Deflation Myth" may end sooner than later. The US is growing, but not creating jobs. The incumbent President is extremely vulnerable on this political issue and in the mid-term election he showed his practical side, and "protected steel." When the day comes that either our current President puts "jobs first" to be re-elected, or a new US President fulfills his campaign promise to do the same, the current game of the Deflation Paradox will be long over. The only reason the Asians are willing to add to their dollar reserves is because we are sending them jobs. The only reason it makes sense to keep reserves in dollars, is because the dollar is "artificially" strong. Secretary of Treasury Snow was sent to China to make it look like the Administration was "talking tough" on letting the Yuan float. In reality, the deal is we'll just talk, as long as the Chinese are willing to buy more US Treasury bonds. Both sides know that if the rules of the game are changed, the US will be in for a currency and economic shock. For China and the rest of Asia, dollar foreign exchange reserves are viewed as valuable and strategic. If the dollar is to be devalued, the reserves must be diversified from the dollar. The dollar devaluation becomes more likely if the US is forced to allow other powers to have a say in dividing up Iraq's oil, and pressure before the election drives the US President to actually act instead of talk.

With the US Trade Deficit at $500 billion, getting out of the dollar while you can is the only sane thing to do. Moreover, since other major currencies are inflating, all the currencies are ugly; the dollar just wins the "Ugly Contest."

Getting into the Euro, Yuan, or Yen are cyclical plays. The game suddenly becomes, "he who sells the Dollar first wins" and with the Fed holding short term interest rates at 1%, it cost speculators almost nothing to borrow dollars to short against foreign currencies, or buy real assets. Getting into gold, silver and commodities, looks like a much better long term secular play, as the "Deflation Paradox" is about to end.

Richard Benson
September 10, 2003
President
Specialty Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard - Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: [e-mail]


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