Academic journal article ABA Banking Journal

Further Dollar Weakness Likely. (US Dollar)

Academic journal article ABA Banking Journal

Further Dollar Weakness Likely. (US Dollar)

Article excerpt

LED BY THE STRENGTHENING U.S. economy, the global economy, in the year ahead appears poised to turn in its best performance in five years. But although the economy appears to be firing on all cylinders, a large international trade imbalance poses a serious threat to the stability and sustainability of the recovery beyond 2004.

By the broadest measure of international trade balance--the current account--the trade deficit has been 5% of gross domestic product, or $529 billion, over the past four quarters. Current account deficits of this magnitude are unprecedented in U.S. history. Although the root causes of the trade deficit are complex, it is hard to avoid the conclusion that deficits of this magnitude occur in part because U.S. goods are overpriced relative to foreign goods, i.e., after appreciating from 1995 to 2001 the U.S. dollar had become overvalued.

But despite the 17% decline in the trade-weighted dollar since the peak in early 2002, the trade deficit has continued to widen and, at best, is beginning to stabilize. Given the persistence of these large imbalances, further depreciation of the dollar is more likely than not over the next several years. The question of whether further depreciation evolves in a controlled manner or happens more abruptly has significant implications for financial markets and economic performance in general.

An often cited--but unfounded--fear is that the foreign inflows required to finance large trade deficits will somehow dry up. Simple accounting tells us this is impossible--the dollars spent on import purchases in excess of those gathered from export sales finance the deficit. That is to say, the deficit finances itself. …

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