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Everyone knows the US has a growing trade deficit, the difference between the cost of exports and imports. Here are the numbers:

$56.5 Billion. What pundits predicted for January ‘05, and feared might be topped.
$58.3 Billion. What the Commerce Department reported today for January ‘05
$59.4 Billion. The record monthly deficit (11/04)
$66.1 Billion. What the deficit would be at today’s oil prices.

Associated Press business writers explain the discomfort. "The soaring trade deficit must be financed by foreigners willing to hold U.S. dollars in exchange for the products they sell to the United States. The concern has been that the trade deficit at some point could rise so far that foreigners become reluctant to hold dollar-denominated assets such as stocks and bonds."

"Such a development could send stock prices plunging and U.S. interest rates soaring. The mere prospect of such a change has been enough to send the dollar tumbling in recent weeks, following remarks by officials in South Korea and Japan that at some point they might consider holding less in dollar reserves."



Currencies are notorious for rapid losses in value when panic strikes; nobody wants to get left holding something of no value, like little green pieces of paper with former US presidents faces printed on them. Some people say, "The US is huge economy," implying it’s a safe bet that investors will stick with the US. True, perhaps in the long run; however, if I fear that a stock (or country or currency) is over-valued (bubble), I might sell the stock, wait for the bubble to pop, and buy the stock back. Sell high, buy low. Yes, in the long run, I’m still investing in the stock, I just took a little break. Same could apply to the US dollar; let someone else be holding it when the bubble bursts.

So, were do people go when they don’t want to be holding dollars? Hard to say, but it appears they’re going to Euros and to gold. According to the Associated Press, "Gold closed in London at $445.90 bid per troy ounce, up from $440.80 on Thursday [3/11/05]." It’s still trading in New York at about $446. In early February, it was selling for $410, and was selling at about $260 in March 2001.



So what does all this mean? You have a better chance of being prepared if you see it coming. This will be a common theme in the continuing Econ 101 series.
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