Daily Gains Letter

How the Ongoing Trade Deficit Affects Your Investment Strategy

By for Daily Gains Letter |

As U.S. Trade Deficit Deepens, Appeal of Foreign Currencies GrowsThe U.S. Department of Commerce reported that in the month of May, exports from the U.S. economy accounted for $187.1 billion, and imports from the global economy were $232.1 billion.

This situation of more imports than exports caused a trade deficit of $45.0 billion in May. Compared to the previous month, the trade deficit increased almost 11% from April. (Source: “U.S. International Trade in Goods and Services – May 2013,” U.S. Bureau of Economic Analysis web site, July 3, 2013.)

On the surface, the trade deficit may not sound like a big deal, but it has a profound affect on the currency and the gross domestic product (GDP) of a country. Here’s what you need to know: the U.S. economy has been registering a trade deficit since at least January 1992. (Source: “Trade Balance: Goods and Services, Balance of Payments Basis,” Federal Reserve Bank of St. Louis web site, last accessed July 3, 2013.)

A short-term trade deficit isn’t something to worry about—it can happen for many reasons, and can be easily absorbed by a strong economy—but a long-term, continuous trade deficit can be alarming. It can jeopardize the value of a currency and inhibit economic growth.

Essentially, what happens is that the country with a trade deficit is seeing its currency leave its borders. Right now, that means that other countries hold a significant amount of U.S. dollars. If they decide to sell their holdings on the market, it would create a huge increase in the supply of U.S. currency, leading to a lower dollar.

Similarly, GDP is calculated by adding the consumption, investments, government spending, and net exports of a country. When a country registers a trade deficit, it actually subtracts from what it produced—the bigger the deficit, the bigger the impact it will have on growth. For example, if we assume that the U.S. economy will register, on average, a $40.0-billion trade deficit per month this year, that will take away $480 billion from the annual GDP.

If investors believe that the continuous trade deficit will cause the value of the U.S. dollar to go down and want to take advantage of the situation, they may want to look at exchange-traded funds (ETFs) like the PowerShares DB US Dollar Index Bearish (NYSEArca/UDN). This ETF lets investors track the inverse performance of the U.S. dollar compared to six other currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc. (Source: “PowerShares DB US Dollar Index Bearish Fund,” PowerShares web site, last accessed July 3, 2013.)

Anyone who is investing for retirement must know that while a trade deficit is one factor that causes the value of a certain currency to decline, interest rates and interventions by central banks can have their own consequences. Investors should be aware of all of those factors before entering into any currency speculation. However, the longer the trade deficit goes on, the more attractive foreign currencies will become.

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