Sunday, August 10, 2008

Foreingers will not support US trade deficit forever

There is a good reason why the US dollar (USD) has been losing value against its major trading partners since 2002. The US has amassed a pile of international debt, putting its currency in a feeble position.

Think about it. You go to the bank every year to take out a loan because you can’t buy everything that you want (go to college, build a pool, go on vacation, buy a house, whatever), and in order to have it all, you take out loans. Will the bank loan to you indefinitely? No. Even if you make all interest payments on time, eventually the rate at which the bank loans you money will fall. That’s just good business – the bank cannot finance your habit of consuming outside of your means continually. And don’t forget: Even though the bank has cut you off, you are still required to pay interest on all of your accrued debt.

The chart above illustrates that the US has been accruing debt in order to consume outside its means for years. If the US consumes outside its means (trade deficit), then it must borrow from foreigners (private and official inflows of money from its asset sales to foreigners) in order to do so. Foreigners have been more than willing to buy US assets and finance the US trade deficit since 1992.

However, foreigners have recently reduced their net purchase of US assets below the value of the annual trade deficit. The trade deficit, as it stands now, cannot be sustained. One of two things must happen: (1) the US trade deficit must fall further (export more, import less), or (2) foreigners must buy more US assets.

Foreigners have partially lost their appetite for US assets. If foreigners continue to purchase fewer U.S. assets (in net), then trade must balance.

International trade is off balance. Countries like Japan, Canada, China, and Malaysia are saving, amassing piles of foreign exchange. Countries like the US and UK are dissaving, giving up piles of foreign exchange. It took the USD falling low enough for foreigners to lose some interest in the US’ assets (foreign inflows have slowed).

As the US dollar falls, exports rise and imports fall. In practice, the USD has been losing value against a broad basket of currencies since 2002, but the trade deficit has only recently started to stabilize because foreigners were still willing to buy our assets.

The US position has become critical, and something must change. The newest data for net inflows is released by the US Treasury on Friday, August 15). The release will indicate the direction in which the trade deficit and foreign inflows will move. I suspect that net-inflows will start to rise again, relieving pressure on the trade deficit…at least for now.

Please leave comments. Best, Nontruths


  1. Probably I can say with this blog make, more some interesting topics.

  2. This is interesting, pcsolotto. We hear about the value of the US$ on a day to day basis but rarely over a greater length of time. This is an area where the US could really get into trouble and no one is saying anything about it. What do you think the composes the trade deficit? The value of the underlying currencies of all countries matter. Remember when other nations currencies were so inflated that one carried "baskets" of paper around? We, too, could get into that situation.