I’m not economist, but can someone explain why the US would want to run a trade deficit with the rest of the world? Cite
The way I understand it, the US buys more foreign merchandise than it exports. This means that the world should be awash in US greenbacks. But it isn’t, otherwise the US dollar seem to need to be lower than it is.
Does this mean some central bank is buying US dollars back? Isn’t that risky? And why does the US run a trade deficit? Not that I expect it to be a conscious decision by a central authority of course.
Actually, the dollar is down quite a bit from what it used to be. Also, trade balance isn’t the only thing affecting the value of a currency. Economic growth, interest rates, budget deficits etc is important.
One way to offset (or delay) the impact of a trade deficit is for the party running a surplus to buy treasury bonds from the party running a deficit.
One example, the US is currently running a huge trade deficit with China, now totalling $100 - $120 billions a year. China’s national bank is using the surplus to buy US treasury bonds. So in effect, China is financing part of the US deficit. In fact, I just heard on the radio today bankers discussing that China has up until now financed 20% of what the US has had to loan to run its current deficit. This is interesting because a) if China decides to stop loaning the US money, the US would likely have to pay a higher interest on their loans, adding increased cost to running a deficit, and b) if there would be a “showdown” between America and China in the near future, China got some pretty strong cards on their hands.
This is something of an oversimplification (as with all economic explanations) but the answer to this question is sitting right in front of you. A “strong dollar” is relatively more expensive to buy in terms of foreign currency. This has the effect of making American goods more expensive to foreign buyers while at the same time making foreign goods seem cheaper to Americans (we get more for our dollars). A trade imbalance where Americans import far more than they can export would seem to be the natural conclusion of this state of affairs.
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Many central banks all over the world hold reserves of foriegn currencies, especially the dollar. The dollar probably isn’t always going to be your safest bet but it is far, far less risky than many other currencies. For quite some time after WWII the US was considered stable enough to be the central lynchpin in the world’s currency exchange system (all currencies linked to the dollar, which was itself fixed to a fixed price of gold). I believe that arrangement came to an end in the 70’s, but it is indicative of the central role of the dollar.
I’ll leave your question of “why would the US want to run a trade deficit” to the better educated and more eloquent.
Strong dollar means high US trade deficit for the reasons stated above. The current US government is all but saying that they’re trying to engineer a weak US dollar. They don’t dare come out and say it because that would make for bad politics. A weak US dollar would make foreign goods more expensive in the US and US goods cheaper worldwide. It would seriously hurt Europe, since they’ve been a great screaming wad of strong-currency-at-any-cost cultists for the past few years.
I say that the Federal Reserve should knock all supports out from under the Dollar and let it plummet. THEN we’ll see how long the Eurozone can hold out unable to compete with US goods on the world market.
Well I understand the strong dollar leading to a large trade deficit, but the fact that there would be more dollars in circulation because of the imbalance should drive the “cost” of dollars down making the trade deficit shrink. Like I said, I’m no economist.
It seems that the US dollar supply has been soaked up to maintain this trade imbalance. You would think that such an exposure would make the US government attempt to reduce that potential advantage. Does a strong dollar specifically help the US? What happens when the market gets flooded with dollars?
Well Dogface, if the dollar did drop wouldn’t that massively impoverish dollar holders? Would that matter, or would that impact the buying power of potential USA customers?
The Federal Reserve is not “buying up” dollars. Instead, panicky Japanese banks (mostly) have been buying up dollars to shore up their own economy against the possibility that the dollar could get weak enough to damage Japanese trade even further.
I never suggested the Federal Reserve was buying dollars. If they did, wouldn’t they use foreign currencies? To my view that would likely only make the problem bigger by making other currencies cheaper.
Any cite for Japanese being the bulk buyers? I can’t image they’re alone.
The US trade deficit is balanced by a capital account accounts surplus because foreigners are large net-buyers of US financial assets. That’s where the dollars go.
As for allowing the dollar to plummet; if only it were so easy. In addition to the fact that foreign exchange markets are prone to over-react it would make the US financial assets less attractive and foreigners much less likely to finance its deficits. Among other things this could drive interest rates up dramatically.
To simplify, the way it works is that, 1) The US is currently running a huge trade deficit. That’s money out. However, 2) much of the money is reinvested in America, for instance in bonds or stocks. That’s money in. In this case the same money which were “lost” (to put it simple). What American economists are worried about is that the market would shift, say that Asian countries would prefer to place their surplus in Europe. In that case they would exchange their dollars for euroes, and that would flood the market with dollars. A huge volume of dollars in the market doesn’t by itself affect the value of the dollar, it’s affected by the balance between supply and demand.
On a sidenote, one of several reasons the US is running a trade deficit is that Americans are huge consumers of goods, much more than they produce themselves. It’s not certain they will be able to meet current demands from domestic production, and at the same time increase their export, if the dollar were to sink. Maybe someone with better knowledge of current consumption in the US could enlighten us?
“It’s not certain they will be able to meet current demands from domestic production, and at the same time increase their export, if the dollar were to sink.”
I don’t have specific information but I don’t think this should be a problem. Many of the industries which would be helped most by a weaker dollar (eg steel) are operating under capacity. They could increase production easily if their products became more globally compettive The potential problems with a weaker dollar would lie more on the capital account side as mentioned above.
The true test of how strong the dollar is, is how it compares to the value of gold, and the price of gold is going up.
YOu cant measure weakness of the dollar against the weakness of the pound, or the weakness of any other weak currency.
Continued, and never ending trade deficits will eventually make the dollar go much much lower. Until the United States starts building lots and lots of factories, and until we once again are the center of manufacturing in the world, the dollar will fall in value. A country must produce more than it takes in, else its currency will decline.
The domestic budget must also change from a projected $480 billion dollars this year(that is a half of a trillion dollars) to be a surplus of a $480 billion. We need to raise taxes(on those who still have jobs) by $480 billion annually to balance the budget.
If you want health care, prescription drugs, etc, then our taxes must be raised by more than $480 billion a year.
Well, Susanann, that’s kind of half right. But if you really raised taxes that much, you’d shut down much of the economy, which would only make the problem worse.
Gold, however, is the explanation of the problem.
The below comes from the World’s Only Living Liberal Gold Bug ([sup]TM[/sup], Marca Registrada, All Rights Reserved).
The dollar is the world’s reserve currency. Prior to this, it was the English pound.
The pound supported an empire, and empires are inherently expensive to run. As I pointed out to Brutus, who qualifies as the most enthusiastic imperialist on these boards, best as I can tell, empires have only one of two choices to keep themselves together, both very expensive:
1 - Keep troops in the conquered territories to keep the natives down.
2 - Subsidize the territories to keep the natives from rebelling.
The British found themselves having to do one or the other at different times in different places, and so their once proud currency went bye bye. We’ve been following much the same course since WWII, with much the same effect on our currency.
Added to that - and this is where gold comes in - we have, like the British before us, the world’s reserve currency. The problem with this is that if you’re the country with the world’s reserve currency, you also get to have the world’s most chronically overvalued currency. This is because everyone finds it to their advantage to do as the Chinese and the Japanese are doing: buy assets denominated in the reserve currency, since these are highly liquid, “safe”, and have the interesting effect of making your goods cheaper in the country that hosts that reserve currency.
The only way to solve this problem is to make the world’s reserve currency something that no government issues. That would be gold, which up until WWI was synonymous with money.
Don’t hold your breath: it won’t again become the world’s reserve currency until the world’s governments are forced into it by a crisis.
You may compare dollar to other major currencies, and you should. I don’t think the price of gold is that important anymore, but I may be wrong.
Not necessarily, as cyberpundit demonstrated above. How much a country is producing is not the key issue. It’s the balance on the account for “business with foreigners”, which includes both import/export of goods and import/export of assets. As long as the US can continue to attract foreign investments to offset the trade deficit they will do fine for quite some time, if not they are in trouble. The problem with offsetting a trade deficit with a positive foreign capital flow is that the US is dependant upon other countries/markets to be less attractive for foreign investments than themselves. The second problem is (simplified) that you can only sell 100% of an assets to a foreigner. Then there is nothing more to sell, meaning the flow of investment capital ceases while the trade deficit is still there.
Yes, no country can run a budget deficit for a long time without sinking the economy. In order to run a budget deficit you will have to borrow money from abroad. In addition to paying back the loan, you will have to pay interest. At some point the amount of interest owed or the cost of converting the loans would surpass available income, and then the economy crashes.
The question is not about raising taxes or enjoying tax cuts, it’s about balancing the budget. Governments can enact tax cuts, but then they should decrease spending too. To spend more money than before and enjoy tax cuts at the same time is a no-no. Currently the US Administration is doing just that, and that’s why there is such a huge budget deficit.
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*Originally posted by Susanann *
The true test of how strong the dollar is, is how it compares to the value of gold, and the price of gold is going up.
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You’re at least 50 years out of date. Gold is not the basis of any major currency and has not been for at least a generation. Gold is now just another commodity.
Dogface, much as I regret having to introduce you to some actual facts, the negative correlation between gold and the dollar, which I ran for my own investment purposes for the period between 1990 and 2002, rates an r-squared of .686, which basically means there’s a 68.6% correlation between a rising dollar and a falling gold price. Or, more recently, vice versa.
That’s a very strong correlation. What it shows is that the market figures that the true measure of the dollar’s worth is - surprise - gold.
Independent research, not to mention independent thought, is a good thing.
While basing a currency on gold doesn’t work anymore(it never really did), the value of gold in US dollars is a reflection of the value of the dollar relative to another strong currency in the world.
If you go back to the early-late 1990’s, the yen/dollar relationship almost llinearly correlated with the price of gold.
Since the late 1990’s early 2000’s, the Euro/dollar relationship almost totally predicts the price of gold(in US dollars). Thus the current high price of gold to us in the US.
You could always throw in the current situation with China deliberately keeping the value of their currency down to keep their exports flowing.
The amount of US dollars in circulation today is scary. As long as the other countries soak them up, we have low interest rates. You can’t do this forever. I only wonder when it happens, rather than if it will happen.