Edge: Kent Engelke

I’m worried about a currency/trade war brought upon by the monetization of debt by most sovereign nations.  What are the infinite number of ramifications including inflation, plunging Europe in darkness for their inability to devalue, to the implosion of the Chinese export dominated economy.

Does the unexpected always occur?  Five years ago if I wrote that the trade deficit would shrink because of record energy exports most would think that I was delusional.  December’s trade gap shrank by 20.7% to $38.5 billion, lower than any estimate in a Bloomberg survey of 73 economists and the smallest gap since January 2010.

The reason — record exports of petroleum and the fewest barrels of crude purchased since February 1997.  In December overall exports increased to the second highest on record.  For all of 2012 exports climbed 4.4% to a record $2.2 trillion, perhaps the result of the declining dollar and increased petroleum exports.  Imports advanced 2.7% to $2.74 trillion.

If the Fed continues to purchase $45 billion in additional debt each month as it has indicated for the remaining of the year, it will buy another $540 billion in treasuries.  The CBO is currently estimating the 2013 deficit to be $845 billion.  If the Fed was to purchase $540 billion in treasuries and the Treasury was to issue $845 billion in new debt to fund this deficit, the Fed would be buying an equivalent of 64% of 2013 government debt issued.

To put this data into perspective, as recently as calendar year 2007, the total debt of the US increased by $549 billion, or roughly the amount of debt the Fed may buy this year.

The purchase of this debt is accomplished via monetization, which is printing dollars.  This monetization directly impacts the value of the dollar, which in turn impacts trade.

Several times I have commented the odds are around 50 percent that a currency/trade war can erupt as an effect of global monetization.  [Note:  It is very common for a struggling economy to devalue its currency to boost production as exports become cheaper and imports more expensive].

At some time this monetization will have an inflationary impact.  To date it has not.  Indeed, this monetization has also artificially suppressed long-term interest rates.

I will vigorously argue when the proverbial last grain of sand is added to the sand pile which in turn causes the sand pile to collapse, it will be very ugly. Federal spending is unsustainable and must be curtailed.

The Edge Question series:

• Edge: What Should We Be Worried About?
• Edge: Tadas Viskanta
• Edge: Kent Engelke
• Edge: Tom Brakke
• Edge: Doug Short
• Edge: Michael Kitces
• Edge: Milevsky, Ritholtz, Zweig, Ferri and More

Kent Engelke is Chief Economic Strategist at Capitol Securities Management.

Advertisement