If the United States is to significantly reduce, eliminate its trade deficit, the dollar may have to weaken significantly. How much is unclear, though, as history shows large dollar declines are rare and have unpredictable consequences for trade.
Reducing the US trade deficit is
the key goal of President Donald Trump’s economic agenda. This is because he
believes it reflects decades of other countries “ripping off” America to the
tune of hundreds of billions of dollars annually.
Source:
https://en.wikipedia.org
If a weaker exchange rate is the
Trump administration’s goal, it is on the right track, with the greenback down
nearly 10% in 2025. This is because of growing concerns over Washington’s
fiscal trajectory and policy credibility as well as the end of “US exceptionalism”
and the “safe haven” status of Treasuries.
A 15% fall in the dollar during
Trump’s first term had no impact on the trade deficit, which remained between
2.5% and 3% of gross domestic product (GDP) until the pandemic. Making a dent
in the US deficit will therefore require a much bigger move.
The United States has run a
persistent trade deficit for the past half-century, as insatiable consumer
demand absorbs goods from around the world. This with a voracious appetite for
US assets from overseas has kept capital flowing into the US. The only
exception was in the third quarter of 1980, when the US posted a slender trade
surplus of 0.2% of GDP, and trade with the rest of the world almost briefly
balanced in 1982 and 1991-92. But these periods all coincided with – or were
the result of – sharp slowdowns in US economic activity that ultimately ended
in recession. As growth shrank, import demand slumped and the trade gap
narrowed. The dollar only played a significant role in one of them. In 1987,
the trade gap was a then-record 3.1% of GDP. But it had almost disappeared by
the early 1990s, largely because of the dollar’s 50% devaluation from 1985-87,
its biggest-ever depreciation.
That three-year decline was
accelerated by the Plaza Accord in September 1985, a coordinated response
between the world’s economic powers to weaken the dollar following its
parabolic rise in the first half of the 1980s. But that does not mean large
depreciations always coincide with reductions in the trade deficit. The
dollar’s second-largest decline was a 40% fall between 2002 and mid-2008, just
before Lehman Brothers collapsed. But the US trade deficit actually widened
throughout most of that period, peaking at a record 6% of GDP in 2005.
While it (deficit) had shrunk by
more than three percentage points by 2009, that was due more to plunging
imports during the Great Recession than the exchange rate. These two episodes
of deep, protracted dollar depreciation stand out because over the past 50
years, the dollar index has only had two other declines exceeding 20%, in
1977-78 and the early 1990s, and a few other slides of 15% to 20%. None of
these had any discernible impact on the US trade balance.
The US administration is correct
that the dollar is historically strong today by several broad measures. But how
much would the dollar have to fall to whittle away the yawning trade deficit,
which last year totalled US$918bil, or 3.1% of GDP? Some believe a 20% to 25%
depreciation over the next two years would see the deficit “vanish”.
History suggests this may be
challenging without a severe economic slowdown. But that’s a risk the
administration seems prepared to accept until the MAGA supporters turn against
TACO (“Trump Always Chickens Out”) Trump! Meanwhile, we must live with
volatility, uncertainty and sometimes plain stupidity!
Reference:
Only
a dollar slump can fix US trade deficit, Jamie McGeever,
Insight, The Star, 29 May 2025
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