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Asset prices and their effect on the U.S. trade balance

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  • Economics

Abstract

Asset Prices and Their Effect on the U.S. Trade Balance Economic SYNOPSES short essays and reports on the economic issues of the day 2009 � Number 31 T he U.S. trade deficit has steadily widened since theearly 1990s, reaching a level of about 7 percent ofgross domestic product (GDP) in 2006. The “trade balance” is the difference between a country’s exports and imports. A deficit implies that a country imports (buys from the rest of the world) more than it exports (sells to the rest of the world). When a country has a trade deficit, it sells its assets—bonds, equity, or direct investment—to the rest of the world. In effect, the country is borrowing to finance current consumption. Eventually, these sold assets produce income for their new owners in the rest of the world. This income is paid in dollars, but the rest of the world uses those dollars to buy either more assets or goods and services. Therefore, future U.S. exports must increase to repay the holders of U.S. assets so trade deficits do not grow forever. What factors can push the U.S. trade balance to a more sustainable level? Some economists have suggested that a large trade deficit should cause the dollar to depreciate. The underlying logic is that a cheaper dollar will lower the price of U.S. exports and raise the domestic price of U.S. imports. Thus, the United States would import less and export more, which would return the trade balance to a more sustainable level. Recent analysis, however, suggests that a dollar depreciation is unlikely to close the trade gap.1 A problem occurs because the prices of many U.S. imports are denominated in dollars, so the prices that U.S. importers pay are rela- tively unchanged after a depreciation. As a result, the demand for imports does not decline much, at least in the short term. Although exports are more responsive to exchange rate changes, it is unlikely that an increase in exports is sufficient to close the entire trade gap. What other forces could drive the trade balance? As

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