Forex Blog: Currency Trading News & Analysis.

May 31st 2005

Declining Dollar Fails to fix trade deficit

Economic theory suggests a nation experiencing a trade imbalance will witness an adjustment in its currency, which will ultimately correct the imbalance. Empirical evidence has shown that this ‘correction’ usually occurs 18 months after the currency begins to depreciate. In this case, the astronomical $650 Billion US current account deficit should have declined 18 months after the USD began to depreciate. However, the USD began a downward trend several years ago, and the US trade deficit has shown no signs of narrowing.

Analysts have tried to explain this phenomenon by arguing the US is an economic anomaly. First, a significant portion of US trade takes place between US companies located in different nations. This type of trade is based on microeconomic factors, and is not conditional on exchange rates. Second, American consumers represent the largest market in the world. Thus, foreign businesses have reacted to a declining USD by lowering their prices proportionately, so as to mitigate changes in the exchange rate and preserve market share. The Wall Street Journal reports:

Importers are hesitant to raise prices to offset a falling dollar, because that would likely cut into market share.  That, in turn, short-circuits of of the main ways a falling currency is supposed to curb imports.

Read More: Dollar-Deficit Ties go awry

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Posted by Adam Kritzer | in US Dollar | No Comments »

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