THE DOLLAR'S DEPRECIATION AND THE U.S. TRADE DEFICIT
Throughout the 1980s, the value of the U.S. dollar has experienced major fluctuations. From its low in 1980 to its high in February 1985, the dollar's exchange rate appreciated over 47 percent on a trade-weighted basis against the currencies of its major trading partners. It was widely argued that much of the dollar's appreciation was due to relatively high interest rates in the United States, resulting from uncapped federal budget deficits, which attracted foreign investment to the United States, increased the demand for the dollar, and bid up its price. 1
Although increased foreign investment helped generate funds to finance the U.S. government's budget deficits, the ensuing dollar appreciation triggered trade deficits for the United States. The soaring dollar swelled imports by making overseas goods cheaper for Americans and discouraged exports by raising prices foreigners pay for U.S. goods. By 1985 the United States faced a deficit of $148 billion in its merchandise trade balance. The merchandise trade deficit with Japan alone amounted to nearly $50 billion. This was followed by a record trade deficit of some $170 billion in 1986, which continued throughout 1987.
It was argued that an adversarial trading relationship existed between the United States and Japan, whereby Japanese products displaced goods produced by U.S. manufacturers without compensating purchases from Japan. By 1986 Japan had the world's largest-ever surplus of liquid funds, some $640 billion, practically all in cash and short-term government securities. This sum was several times what Japan required to finance its trade expenditures: it was so large that for six years Japan could pay for all of its imports without having to earn a single yen via exports.
Responding to a deteriorating competitive position, U.S. companies and labor unions demanded additional protectionist restraints on U.S. imports.