Ingo Schmidt writes: >What is noteworthy is that, at the same time as the dollar declined, the US foreign deficit reached record highs, contrary to the market logic that predicts a smaller current account deficit in the case of currency depreciation. This is a new development. In the past, depreciations and decreasing current account deficits actually went hand in hand. What does the current de-linking of dollar rates and the US current account position imply?<
I haven't checked the exact facts on this description, but the the fact that "at the same time as the dollar declined, the US foreign deficit reached record highs" is _not_ "contrary to the market logic that predicts a smaller current account deficit in the case of currency depreciation." A currency can easily fall at the same time we see a larger current account deficit. First, as the US$ falls (in terms of Euros), the $ price of goods imported from (say) Europe rises. But the US does not cut the real volume of its imports as quickly as the $ falls. (In terms of "market logic," the demand for imports is inelastic, at least in the short term.) So the total price of US imports ($ price times real quantity of imports) can actually rise. At the same time, as the US$ falls, the Europeans don't automatically increase the real volume of their imports from the US in step with the depreciation of the $. (Again, the demand for imports -- this time seen from the European point of view -- is inelastic, at least in the short-term.) That means that the total price of European imports (= that of US exports) can actually fall as the US$ falls. So, the total price of US net exports can fall even though the US$ is falling. The other elements of the current account balance don't change very quickly, so that the current account balance can and likely will get worse. This phenomenon is so familiar to foreign trade buffs that it even has a name, the "J curve" effect: as the US$ falls, the trade and current account balances get worse and then (eventually) get better. (Note the repeated phrase "in the short term" above.) It's hard to tell how long it takes before the corner is turned and trade and current-account benefits start getting better, but it usually happens, especially for a powerful country like the US. It is also not true that "In the past, depreciations and decreasing current account deficits actually went hand in hand." It (the J curve phenomenon) happened in the later 1980s. The J curve effect does make the US situation worse, however. Instead of the wished-for or hoped-for instant recovery of the trade and current-account balances, they get worse. That might stimulate a speculative crash of the US$. But it doesn't have to do so. -- Jim Devine / "Segui il tuo corso, e lascia dir le genti." (Go your own way and let people talk.) -- Karl, paraphrasing Dante.