Stock Markets Pummeled for Week While Near-Record Trade Deficit Posted Again

Stocks took another beating on Friday, with the blue chip index dropping almost three-quarters of a percent and broader indices losing about as much. The closing last week on a strong up-tick gave bullish investors and mainstream media pundits air-time to praise the end of the equity doldrums and the possibility of big gains to come; but this past week saw the optimists' portfolios taken out to the field and shot as the business-as-usual rosy talk out of the White House and the Federal Reserve lost further traction at the ground-level, where businesses and consumers are being ground down under rising interest rates, rising energy prices, and no signs of signficant concern, much less action, from Washington.

The U.S. trade deficit for January beat expectations, posting the second largest flood of red ink on record, exceeded only by last November's net blood-letting of greenbacks to foreign importers. This time, exports grew noticeably because the dollar had dropped far enough to make U.S. exports in overseas markets fairly attractive, but the pace of imports moved upward at an even faster sprint, putting more dollars on balance into the foreign reserves of other countries.

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The money in other countries' currencies that a nation holds is called its "foreign reserves," and this value depends upon how much it imports from versus how much exports to each of its trading partners.

  During the month of January, oil prices actually declined somewhat, meaning that the boost in the trade deficit cannot be attributed to the more recent run-up in crude prices that have sent gasoline at the pump into holy-cow! territory. Much of the January import frenzy came in electronic goods, but foreign imports of textiles—especially clothing out of China, now that certain import quotas have expired—started to show a strong upward trend. As more goods from China begin to flow into the U.S. over the coming months, along with the current blast-off of oil prices, prospects for bringing the trade deficit down are not looking up.

On Thursday, Federal Reserve Board Chairman Alan Greenspan, clearly knowing that the trade deficit numbers that would be released on Friday didn't look good, claimed that massive trade deficits don't worry him, but the massive federal budget deficits do. The mystery to some outside observers was that Mr. Greenspan failed make it clear that the federal budget deficit is linked to the trade deficit; and he didn't mention that the rising interest rates that the Federal Reserve is orchestrating could not only make the dollar stronger, which would help the trade gap situation, but that those same rising interest rates will give importers an incentive to sell more goods in the United States to acquire greenbacks that can be used for long-term investment here.

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High domestic interest rates attract foreign investment; but to make such investments, the foreigners have to gather U.S. money, which they do through the imports they sell here.

  The Fed Chairman's lack of candor concerning this complicated relationship could be attributable to his unwillingness to admit that the Federal Reserve is tangled in a trap: even though the Fed has to raise interest rates to combat the looming inflation that Greenspan claims is nowhere in sight, the Fed's action might cause the trade gap to worsen rather than improve. As an unfortunate consequence of this, the most obvious way to bring down the trade deficit at this point is for high domestic interest rates to cause such economic damage that consumers will no longer be able to afford to purchase imports in record amounts. The problem with this scenario is that, if interest rates do rise to such levels, greenbacks will become even more attractive to foreigners who could use them to invest in the U.S., meaning that importers might lower their prices just to attract consumer purchases.

Of course, adding fuel to the whole fire are the record federal budget deficits that the White House and its Republican allies hate so much that they keep causing them year after year.

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The Federal Reserve directly controls certain key, short-term rates; but it controls long-term interest rates only to the extent that the short-term rates affect long-term rates; but long-term interest rates are influenced by a number of factors aside from just short-term rates.

  The government will pay whatever interest rates it must to fund its excess of expenditures over revenues. Foreign investors are flush with greenbacks but have recently been playing coy about using them to lend Uncle Sam its regular fixes of borrowed money; so the U.S. government, to attract lenders, has been pushing long-term interest rates up at a pace nearly matching what the Fed is doing to short-term interest rates under its control. Despite numerous claims by the Federal Reserve and the White House that the economy is in a full expansionary mode, few economists not on the payroll of the government or its private-sector cheerleading squads would be so bold as to claim that an economy with rising interest rates, record budget and trade deficits, and a decided lack of leadership from Washington can long sustain itself before taking a downturn strong enough to be noticed by everyone except those who, for more than four years, now, have caused the difficulties.