13/06/2011 – Think Lower Trade Deficit Is Bullish For the Stock Market? Now See This Chart

Before you join the crowd in thinking that shrinking trade

gap is bullish for stocks, read this excerpt from the 2011

edition of our popular free Club EWI resource, The

Independent Investor eBook.

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Over the past 30 years, hundreds of articles — you can

find them on the web — have featured comments from economists

about the worrisome nature of the U.S. trade deficit. It

seems to be a reasonable thing to worry about. But has it

been correct to assume throughout this time that an expanding

trade deficit impacts the economy negatively? Figure 8 answers

this question in the negative.

In fact, had these economists reversed their statements

and expressed relief whenever the trade deficit began to

expand and concern whenever it began to shrink, they would

have accurately negotiated the ups and downs of the stock

market and the economy over the past 35 years. The relationship,

if there is one, is precisely the opposite of the one they

believe is there. Over the span of these data, there in

fact has been a positive — not negative — correlation

between the stock market and the trade deficit.

It is no good saying, “Well, it will bring on a problem

eventually.” Anyone who can see the relationship shown

in the data would be far more successful saying that once

the trade deficit starts shrinking, it will bring on a problem.

Whether or not you assume that these data indicate a causal

relationship between economic health and the trade deficit,

it is clear that the “reasonable” assumption

upon which most economists have relied throughout this time

is 100% wrong.

Around 1998, articles began quoting a minority of economists

who — probably after looking at a graph such as Figure 8

— started arguing the opposite claim. Fitting all our examples

so far, they were easily able to reverse the exogenous-cause

argument and have it still sound sensible. It goes like this:

In the past 30 years, when the U.S. economy has expanded,

consumers have used their money and debt to purchase goods

from overseas in greater quantity than foreigners were purchasing

goods from U.S. producers. Prosperity brings more spending,

and recession brings less. So a rising U.S. economy coincides

with a rising trade deficit, and vice versa. Sounds reasonable!

But once again there is a subtle problem. If you examine

the graph closely, you will see that peaks in the trade deficit preceded recessions

in every case, sometimes by years, so one cannot blame recessions

for a decline in the deficit. Something is still wrong with

the conventional style of reasoning. 

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