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The Trade Deficit and Exchange Rates

The Trade Deficit and Exchange Rates

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[Q:] Since the U.S. Dollar is weak, shouldn't that imply we export more than we import (i.e., foreigners get a good exchange rate making US goods relatively cheap). So why does the U.S. have an enormous trade deficit?

[A:] Great question! Let's take a look.

Parkin and Bade's Economics Second Edition defines trade balance as:

    The value of all the goods and services we sell to other countries (exports) minus the value of all the goods and services we buy from foreigners (imports) is called our trade balance
If the value of the trade balance is positive, we have a trade surplus and we export more than we import (in dollar terms). A trade deficit is just the opposite; it occurs when the trade balance is negative and the value of what we import is more than the value of what we export. The United States has had a trade deficit for over the last ten years, though the size of the deficit has varied during that period.

We know from "A Beginner's Guide to Exchange Rates and the Foreign Exchange Market" that changes in exchange rates can greatly impact various parts of the economy. This was later confirmed in "A Beginner's Guide to Purchasing Power Parity Theory" where we saw that a fall in the exchange rates will cause foreigners to buy more of our goods and us to buy less foreign goods. So theory tells us that when the value of the U.S. Dollar falls relative to other currencies, the U.S. should enjoy a trade surplus, or at least a smaller trade deficit.

If we look at the U.S. Balance of trade data, this doesn't seem to be happening. The U.S. Census Bureau keeps extensive data on U.S. trade. The trade deficit does not appear to be getting smaller, as shown by their data. Here is the size of the trade deficit for the twelve months from November 2002 to October 2003.

  • Nov. 2002 (38,629)
  • Dec. 2002 (42,332)
  • Jan. 2003 (40,035)
  • Feb. 2003 (38,617)
  • Mar. 2003 (42,979)
  • Apr. 2003 (41,998)
  • May. 2003 (41,800)
  • Jun. 2003 (40,386)
  • Jul. 2003 (40,467)
  • Aug. 2003 (39,605)
  • Sep. 2003 (41,341)
  • Oct. 2003 (41,773)
Is there any way we can reconcile the fact that the trade deficit is not decreasing with the fact that the U.S. Dollar has been greatly devalued? A good first step would be to identify who the U.S. is trading with. U.S. Census Bureau data gives the following trade figures (imports + exports) for the year 2002:
  1. Canada ($371 B)
  2. Mexico ($232 B)
  3. Japan ($173 B)
  4. China ($147 B)
  5. Germany ($89 B)
  6. U.K. ($74 B)
  7. South Korea ($58 B)
  8. Taiwan ($36 B)
  9. France ($34 B)
  10. Malaysia ($26 B)
The United States has a few key trading partners such as Canada, Mexico and Japan. If we look at the exchange rates between the United States and these countries, perhaps we will have a better idea of why the United States continues to have a large trade deficit despite a rapidly declining dollar. We examine American trade with four major trading partners and see if those trading relationships can explain the trade deficit:

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