What's Behind The U.S. Trade Deficit?

from the St Louis Fed

Running a trade deficit is not new for the U.S. It’s been mostly running trade deficits since the 1970s. However, this trade imbalance has recently become hotly scrutinized. Much of the concern stems from a fear that trade deficits lead to declines in manufacturing sector employment.

In a recent Regional Economist article, Assistant Vice President and Economist Yi Wen and Research Associate Brian Reinbold explored why the U.S. runs a trade deficit, why manufacturing employment is declining and how these two are related. They also looked at the trade relationship with China, which is the largest supplier of goods to the U.S. - and by extension, its biggest creditor.

The long-running U.S. trade deficits and the emergence of China as a major creditor nation are largely the result of two economic forces, they wrote:

  1. The rise of the U.S. currency and U.S. government debts to become the world currency and a global form of liquidity and store of value following the collapse of the Bretton Woods system
  2. The comparative advantage shift in goods production, which caused labor-intensive manufacturing to move from the U.S. to nations with cheaper labor

The Bretton Woods System

After World War II, a new international monetary system, referred to as Bretton Woods, established the U.S. dollar as an international reserve currency. The dollar would be backed by gold, and any country could exchange dollars for gold. “This new system facilitated and stabilized global trade, especially trade among the industrialized nations," Wen and Reinbold wrote.

However, after years of U.S. aggregate-demand growth, countries running trade surpluses with the U.S. sought to exchange their dollars for gold, rapidly shrinking U.S. gold reserves, the authors noted. The Bretton Woods system effectively ended in 1971 when the U.S. ended dollar convertibility to gold.

Subsequently, because of the historical strength of the U.S. dollar, it became the global currency, and U.S. government securities became the most-demanded foreign reserve in the world, the authors pointed out.

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Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

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