Question

The rise in the value of the dollar between 1980 and 1985 occurred when the

United States was running a large and growing trade deficit. Explain the

factors that led to this rise.

Answer 1

answer-

Many economists have emphasized the importance of fundamental accounting identities in explaining trade flows. For example, the Economic Report of the President notes that, by definition, any excess of national investment over national savings must be financed through an inflow of foreign capital, which must, in turn be matched by an offsetting deficit in our current account, the broadest measure of our trade balance. In this view, a low level of national savings must necessarily result in a trade deficit.

However, just because trade is influenced by macroeconomic forces such as savings rates and currency values, it does not follow that trade policy cannot influence the level of the trade deficit. There are at least two key issues that must be considered. First, what determines the macroeconomic flows that affect trade, and second, how can public policies at home and abroad affect our trade balances?

Accounting identities do not, and cannot, explain the causal relationships between savings, investment, and trade flows. Do low savings rates cause trade deficits, or does causation run in the other direction? A trade deficit reduces the incomes of domestic workers, pushing many into lower income brackets. Families with lower incomes generally find it much harder to save. Therefore, increasing trade deficits can and do reduce national savings.
The CEA report also notes that, since 1980, the size of our trade deficit has been closely correlated with movements in the exchange value of the U.S. dollar. As the dollar appreciated in the early 1980s, the trade deficit expanded, and the deficit shrank as the dollar fell later in the decade. The CEA emphasizes the influence of macroeconomic factors, such as U.S. monetary policy, in determining exchange rates. However, our exchange rates and trade deficits with several key countries are also heavily influenced by other countries’ economic policies.

For example, in 1994 China devalued its currency by 30% against the dollar. Since that time it has continued to purchase dollars and by 1997 it had accumulated total reserves of $143 billion. Since then, our bilateral deficit has increased by 25% or more per year. China’s mercantilist policies contributed significantly to the trade problems of other countries in South Asia, many of which were swept into the financial crisis which began in mid-1977.

Japan has also intervened heavily in foreign exchange markets, with similar consequences. In 1995, Secretary Rubin reached an agreement with Japanese Vice Minister of Finance for International Affairs Eisuke Sakakibara to devalue the yen. In 1996, more than $125 billion in official capital (asset) purchases flowed into the U.S., much of it from Japan. The yen has lost 50% of its value since 1995, and our bilateral trade deficit widened rapidly last year as a result.

Exchange rate intervention is not our only trade problem, by any means. Over the longer term, since 1982, the yen has doubled in value, and yet our bilateral deficit has never fallen below $19 billion since then, and the deficit has exceeded $40 billion in every year since 1985. Japan maintains numerous structural barriers to U.S. imports. For example, Japan condones restrictive practices that have limited U.S. penetration of their domestic markets for film, auto parts, flat glass, and many other products.

China maintains even heavier import restrictions than Japan. These barriers have generated our most imbalanced bilateral trade relationship: our imports from China in 1997 were $63 billion while exports were only $13 billion, a 5-to-1 ratio, leading to a $50 billion bilateral deficit. China also uses discriminatory offset and technology transfer policies to capture market share and move rapidly upscale into high-tech products such as automobiles, computer products, and aircraft. Over 148,000 jobs in aerospace and related industries alone could be lost over the next two decades because of offsets policies and other types of outsourcing.

Many other countries in Europe, Asia, Africa, and Latin America use protected home markets as a base to support industries that dump excess output in the U.S. market, especially in capital-intensive sectors such as steel and semiconductors. Government subsidies also distort trade flows, especially in high-tech industries.

, the dollar has also been appreciating because of significant private capital inflows into the U.S., because of relatively high rates of growth here, and in search of a “safe haven” from the Asian financial crises. These private flows have also contributed to the growth of our trade deficit, while also pushing asset prices (such as the stock market) to unsustainable levels. This experience shows that our trade balance can be destabilized by both public and private forces. It is also worth noting that the surge in private capital inflows was made possible, in part, by the liberalization of capital outflows from many developing countries, in the 1990s, often with IMF encouragement.

U.S. trade deficits have been increased by both mercantilist, macroeconomic policies of foreign governments as well as interventions and distortions in individual product markets. They have been exacerbated by the Asian financial crisis and financial market deregulation. The resulting deficits have contributed to widening income inequality and the stagnation of income and productivity growth in the U.S.