Sprott: Investment Outlook (August 2011) "The Greatest Trade of All"

By Kevin Bambrough, Sprott Asset Management

On its way to becoming the world’s greatest superpower, the United States pulled off some truly remarkable trades. Two notable transactions come to mind and were both outstanding bargains.

- The Louisiana Purchase (purchased from the French)

- Alaska (purchased from the Russians)

For a mere $15 million, America instantly doubled its size with the 1803 purchase of the Louisiana territory.¹ Sixty-fouryears later, oil-and mineral-rich Alaska was obtained for a paltry $7.2 million.² Even adjusting for inflation, the combined value of these deals in today’s dollars would be very small.

The Greatest Trade in US History

However, these two transactions pale in comparison to the greatest trade of all time, one which remains ongoing. This particular trade has allowed the US to exchange more than $8 trillion worth of paper for an unbelievably enormous amount of real goods and services over 36 straight years. We’re referring, of course, to the United States trade deficit. As Chart 1 shows, imports have exceeded exports every year since 1975. For much of the past decade, America’s annual trade deficit has soared past the $600 billion mark, while the accumulated trade deficit has moved relentlessly higher.

Chart 1

Source: US Census Bureau, Foreign Trade Division

Back in November 2003, Warren Buffett penned an article for Fortune magazine warning that America’s trade deficit could no longer be ignored.³ He felt that America’s “net worth” was “being transferred abroad at an alarming rate.” At the time, the accumulated trade deficit had only reached a few trillion dollars, but it has grown over the last seven years by an average of over $600 billion per annum.⁴ As Buffett wrote at the time, “our national credit card allows us to charge truly breathtaking amounts. But that card’s credit line is not limitless.” Makes you wonder what he must be thinking now that the accumulated trade deficit has since ballooned.

Charts 2 and 3 below demonstrate how much of the deficit resulted from imported oil and autos, two major items of which the United States is a net importer.

Addicted to Imported Oil

Nearly 40 percent⁵ of the $8 trillion⁴ trade debt is a direct result of America’s continuing dependence on foreign oil. Even though the US is the world’s third largest oil producer, it has had to import 90 billion barrels of oil at a net cost of $3.1 trillion since 1975.⁵ Nearly $2 trillion⁵ of that was incurred over the past ten years, as the prices, rather than volumes, of imports rose. Roughly two-thirds of the oil consumed in the US over the past decade is imported, and overall the US has consumed over 12 percent of the rest of the world’s oil production since 1975.⁶ America’s rapidly widening oil deficit may even accelerate as demand from China, India and other emerging economies pushes oil prices ever higher.

Chart 2

Source: US Energy Information Administration

…And Imported Automobiles

$2.65 trillion.⁷ That’s the total cost of the 330 million⁷ imported cars Americans have purchased over the past 36 years. There’s little indication that import purchases will slow down anytime soon, as imports surged to $115 billion in 2010, exceeding exports by $76 billion.⁷

Chart 3

*1976 – 1988: Estimated by Sprott as we could not find actual historical data
Source: United States International Trade Commission

We could include countless examples and all of them collectively would not do justice to what an amazing trade this has been for the United States. Stop and think for a moment about how many hours of labour, manufactured goods and non-renewable resources the United States has been able to acquire over 3.5 decades in exchange for paper promises that promise nothing but additional paper. It is truly remarkable.

When a Dollar was a Dollar

“[US dollars] have value because everybody thinks they have value. Everybody thinks they have value because in everybody’s experience they have had value.” – Nobel laureate economist Milton Friedman⁸

Exporting nations have willingly financed this $8 trillion trade deficit by accepting US dollar denominated paper promises in exchange for tangible goods sold. But perhaps most important of all, they’ve continued to hold and accumulate these paper promises rather than exchange them for real assets.

Presumably, they have done so on the belief that one day they will be able to convert these paper promises for at least an equivalent value of goods and services. This requires faith that the purchasing power of the US dollar will not decline by more than the returns of their paper promises and that someone in the future will be willing to give up a tangible asset in exchange for them.