Market analysts have recently focused on the international trade balance as a source of growth for the U.S. economy. But while technically a source of growth, it could also be a leading indicator of more trouble ahead.
We have had a negative trade balance for some time, i.e., we've been importing more goods than we export. That imbalance can be attributed to several factors, including the falling exchange rate of the dollar, changing competitive issues and the cost of petroleum.
In the simplest of terms, the exchange rate is the ratio of the market value of two currencies. A currency's value depends on a number of factors: its importance in world trade, the economic outlook for the country, the country's debt service, its balance of trade, and investors' willingness to put their money there. In the past, some valuation has been also placed on the type and stability of the government involved.
The value of U.S. currency has fallen significantly as result of rising budget deficits (economic outlook) and as Americans purchased more imported goods (balance of trade). At the same time, the government had to borrow more money to fund the deficits, placing even more demand on available sources.
Needless to say, the parties lending these funds wanted higher returns on their investments because of the increased risk they believed the growing deficits presented. Since interest rates were not moving dramatically, however, investors were dependent on a decrease in the exchange rate for the U.S. dollar to give them a higher rate of return.
Unfortunately, that decline in the exchange rate had a number of negative repercussions. First, it led to concern over the economic outlook for the U.S. economy. And had the economy slipped into a recession, there would have been a run on the dollar, which would have further lessened its value. Second, foreign goods became more expensive or American consumers, thus putting a crimp in their purchasing power.
Third, the lower exchange rate had a negative impact on the price of crude oil. Since crude oil is typically traded in U.S. dollars, producers lose some of their purchasing power if the price of crude does not move directly with the devalued U.S. dollar. Therefore, a declining dollar is likely to drive up the cost of crude for those who trade for it in U.S. dollars.
However, I still think the positive consequences of a devalued dollar outweigh the negatives. For the first time in nearly three decades, goods produced in the U.S. have become very competitive in world markets. There has been an increase in demand for everything from heavy equipment to agricultural products because foreign markets can buy more U.S. goods, thanks to the rising value of their local currencies.
Another benefit is that a devalued dollar puts pressure on the U.S. to change the way it produces and consumes goods. That ability to change is the hallmark of our economy. We have the luxury of making adjustments based on market conditions, not government mandate.
This enables us to react more quickly and develop more ways of addressing cost imbalances. Reducing the rate of growth for overall consumption is not bad if it allows markets to refocus on sustainable growth.
As far as the increase in the price of crude oil is concerned, it will force us to use less fuel, as well as find less expensive sources of fuel.
The bottom line is that swings in the trade balance mask the underlying growth potential of an economy. However, these swings can provide the necessary impetus for change that will benefit the economy in the long run.