Term Paper on "U.S. Trade Deficit"

Term Paper 5 pages (1598 words) Sources: 4

[EXCERPT] . . . .

U.S. Trade Deficit

United States Trade Deficit

The balance of trade is an economic measurement highlighting, amongst other things, the health and stability of a national economy. It is calculated by subtracting a country's imports from the total amount of exports, for a given period of time, generally one year. At the end of a give time period, the balance trade can be positive or negative. The positive balance trade is referred to as a trade surplus, meaning that the country exported more items than it imported. If on the other hand, the country imported more than they delivered to other economies, the resulting trade balance is called a trade deficit.

The United States of America first reported a trade deficit in 1970, deficit which was accentuated in 1997. 1991, an year of economic recession, was the last year when the United States reported a surplus. Since then, the trade deficit continued to steadily increase, in order to increase massively in 1997 and onwards:

Source: U.S. Census Bureau Foreign Trade Division, 2006

http://www.census.gov/foreign-trade/statistics/historical/gands.txt

The highest trade deficit was registered within the United States in 2007, when it reached the record high value of $847 billion. Combined with federal deficit, numerous expenses with national safety and security, the war in Iraq, the disastrous effects of the Katrina hurricane, increasing oil prices (even more when two thirds of the consumed oil comes from imports) or the real estate crisis, the trade deficit generated economic instability and the value reduction of the American dollar (Central Intelligence Agency, 2008)

On February 8th, 2008, the accumulated trade deficit for 2008, including the thirty one days of January and the first eight days of February, reached a total value of $74 billion. The value is calculated by the American Economic Alert and it updated to the second; the American trade deficit increases by the second (American Economic Alert, 2008).

Several economists blame the created situation on the American authorities and the government, whereas others blame it on the increasing prices of foreign commodities, mainly the record high prices of oil. "The U.S. trade deficit resumed its expansion in April, driven by record oil prices and an appetite for planes, clothing and other foreign goods. [...]However, economists noted that the widening trade deficit largely reflected increased prices for imports, not increased volume of imports" (Bater, 2005).

2. Foreign Investments

Foreign investments are a highly important determinant for the stability and prosperity of an economy. Furthermore, the modern economy embraces and encourages the international circulation of capitals. However, this must be controlled and supervised, for excessive foreign investment could in the end do more harm than good. And the American nation is a relevant example in this sense.

The United States have for years been a desirable destination for the wealthy foreigners who wished to invest their funds in American corporations. And the activities were rarely regulated by any authority, even more since the investments were perceived as development opportunities for both parties. But why exactly were foreign investors so well received? It could be because of the libertine and free spirit of the Americans. But it could also be due to the high levels of consumption registered by the American population, both individuals within the society as well as private organizations or state institutions. These increased levels of consumption meant that most Americans were spending their money, rather them saving it, and in the end a crisis occurred. The crisis referred to insufficient funds to invest in American companies. The need for foreign investments then occurred.

The U.S. trade deficit is the result of a net inflow of capital to the United States from the rest of the world. Because of our stable and relatively free domestic market, we remain the world's most popular destination for foreign investment. We have become a net importer of capital because Americans do not save enough to finance all the available investment opportunities in our economy. This inflow of capital from abroad allows us to pay for imports over and above what we export. In other words, the trade deficit is simply a mirror reflection of the larger macroeconomic reality that investment in the United States exceeds domestic savings. If we want to change the U.S. trade deficit we must change the rate at which Americans save and invest" (Griswold, 1998).

But recognizing this problem does not imply its immediate resolution. As such, in the short run, until the America population becomes more oriented on saving rather than consuming, the companies still need the foreign investments. But in the same time, the value of the dollar is decreasing and foreign investors might be reticent to transferring more financial resources to the United States. "Once this happens the United States will be forced to increase interest rates (maybe sharply) to continue to attract foreign investments. Higher interest rates in turn will plunge the economy into recession" (Shostak, 2006).

3. The U.S. Dollar trade deficit with one country or in one year is not necessarily worrisome, and according to standard economic theory, will correct itself over time. But the theory has been proved wrong over the last 30 years as the United States has run consistent and increasing trade deficits. The enormous size of the trade deficits over the last several years raises the possibility of a severe international economic crisis should foreigners begin to dump the dollars they hold in world currency markets." (American Economic Alert, 2008)

The exchange value of the American currency is highly important for the trade deficit and the explanation is based on basic economics concepts. As such, the economic instability, fear of terrorist attacks, the real estate crisis, inflation, increased competition from Europe and China as well as other factors have lead to the weakening of the U.S. dollar. Now, a weakened national currency can increase the trade deficit in the following meanings:

The U.S. pays more American dollars for the same counter value of products

The U.S. receives fewer American dollars in exchange for their exported goods; ergo, the conclusion that the depreciation of the national currency is highly interconnected with the country's trade deficit.

But the trade deficit is also dangerous for the future of the national currency as it can generate an even higher depreciation. "If the Americans do not begin reducing their trade deficit, there will come a time when foreigners will become less willing to hold dollar denominated assets. This in turn will weaken the U.S. dollar. [...] in short, given the size of the current account deficit it is held that the U.S. dollar has to plunge in a big way against most currencies, and it is not possible to avoid a painful adjustment as a result of this" (Shostak, 2006).

4. Gravity of the Trade Deficit

The constantly increasing U.S. trade deficit is a highly severe problem for the well-being of the American economy. Its gravity is given by numerous effects and implications. For instance, as mentioned before, it can generate the devaluation of the national currency. Then, investors will no longer be interested in possessing the dollars, nor in investing in the country. To once again capture their interest, the state officials will have to implement numerous benefits and monetary regulations which encourage foreign investments, such as increasing the interest rates. This increase of the interest rates means that financing opportunities from banking and other financial institutions will be more difficult to get, and more expensive. Therefore, the companies will have to attract foreign capital. But this will also affect the population as it will limit their possibility of financing their projects. All this could lead to economic recession in the United States.

Another negative consequence which emphasizes on the gravity of the trade deficit is the increasing unemployment rate. "A new study has found that the United States'… READ MORE

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