By Dirk van Dijk of

NEW YORK ( TheStreet) -- What really drove the increase in the trade deficit this month was the non-oil goods side. That deficit rose to $32.31 billion from $27.78 billion in April and $22.38 billion a year ago, increases of 16.3% and 44.4%, respectively.

The rise is most likely related to the strength of the dollar in recent months as a result of the crisis in Europe. This is the principal transmission mechanism for the trouble on that side of the pond to affect the U.S. economy.

The trade deficit really is a much bigger problem than is the fiscal deficit. It is the trade deficit that is responsible for our being deep in debt to the rest of the world, not the budget deficit. That is something that cannot be argued, it is simply an accounting identity.

For every dollar of goods and services we buy that is more than the amount of goods and services we sell abroad each month, we have to either be selling off assets or going into debt by that amount, dollar for dollar.

This month, we effectively sold off Kraft Foods ( KFT); if the deficit is the same size next month, we will effectively sell off Bristol Myers ( BMY). How much longer before we don't have anything left? Actually it is mostly T-bills and notes that are being sold abroad, but the key point is that it is the trade deficit, not the budget deficit, that drives how far we are in hock to the rest of the world.

Inflation or Deflation?

The strength of the dollar in recent months is not a good thing. We need for the dollar to slowly fall in value relative to other major currencies.

Yes, that would result in higher inflation, but right now, more inflation would be a good thing -- the economy is on the edge of deflation. Deflation would raise real interest rates and make it impossible for many debtors to be able to repay their loans, leading many of them to default. Deflations lead to depressions, and need to be avoided at all costs.

The problem is that every country in the world wants to be a net exporter. Unfortunately, unless new trade routes are opened to Mars, that can't happen. For too long, the U.S. consumer has been the buyer of last resort, sucking up the excess production of the rest of the world.


Owing trillions of dollars to China is a very different thing than owing trillions to domestic investors and pension funds. Getting serious about reducing our consumption of oil would be a good place to start bringing down the trade deficit, and a lower dollar would also be very helpful.

The trade deficit is like a cancer on the economy. We don't feel it acutely at any given time, but slowly but surely it is going to kill the economy. Not just put it into a recession for a few quarters (although each dollar increase in the trade deficit translates to a dollar decline in GDP) but a real tangible and permanent decline in the standard of living for the country.

The chronic trade surplus countries -- most notably China, Japan and Germany -- need to take steps to increase their domestic consumption. Their currencies need to rise in value so their consumers will buy more from the rest of the world, and the U.S. -- which is by far the biggest deficit country -- will buy less from them. A stronger euro though would make the problems faced by the Southern European countries that much worse.