Looming Balance of Payments Problem

The market is abuzz with talk about the twin US deficits but one part of the equation is overlooked. The euro was the top performer Monday while the Canadian dollar lagged. German CPI is next and Fed chair Powell will testify to the House Finance Committee in US trading at 10:00 ET (15:00 London/GMT) but the text of the Powell's speech is due for release at 8:30 ET 13:30 London/GMT. The Dow30 trade was stopped out, leaving 2 other indices in progress.

إدارة انعكاس المؤشرات (فيديو للمشتركين)

Click To Enlarge

Here's the issue: The US economy is strong. Unemployment is near all-time lows, corporate profits are soaring, house prices are back at the highs, consumers are in good shape… and yet the government just delivered a gigantic tax cut, among the biggest ever.

What happens to that money? One argument is that it finds its way abroad.

Elaborating further: A US company wants to fill a large order. The US factory is running at capacity and management is unable to find good workers without overpaying, so they forego on filling the order. As a result, the buyer seeks an economy that's relatively slower, such an example is a factory in Mexico that's running at half capacity and eager to complete the order, willing to discount and can deliver ASAP.

That's an oversimplification but that might be what's beginning to happen. It's early but the US trade deficit has grown to $70B/month from $60B/month in two months. That's a big drag on growth. Other drawbacks include debt financing at higher rates, but getting into that would be dancing on thin ice.

Secondly -- and no one is talking about this – is that Trump's tax cut will exacerbate the US twin deficits, making them a larger problem than they already are --a political disaster and an acute economic imbalance.

The Republican brand is tied to fiscal discipline and Trump's brand is tied to balancing trade deficits. So markets haven't particularly cared about the twin deficits for a long time but Washington does care. Markets are increasingly worried about what's coming to solve those problems. Trump will want action on the fiscal deficit, while pressing for action on the trade deficit and on Monday he railed against the WTO so everything is on the table.

Given the ideology of Washington, we could be months away from a trade war and from some harsh cuts to US social spending. In the shorter term, the focus will be on German CPI and Powell's Humphrey Hawkins testimony on Tuesday.