Question

Problem 1.1: Making Sense of the Trade Deficit

a) Explain the difference between the current account and the capital and financial account in the balance of payments.

b) What is a trade deficit?

c) Assume a U.S. firm buys (imports) $5 million (in U.S. dollars) of foreign goods. That transaction by itself increases the trade deficit by $5 million. But, the $5 million will flow back to the United States to purchase either (i) U.S. goods and services or (ii) U.S. assets.

1. How does the way the $5 million comes back to the United States determine whether there will be balanced trade or a trade deficit?
2. How does the U.S. economy benefit from either transaction (the foreign purchase of U.S. goods and services [exports] or the purchase of U.S. assets)?

d) How does the “global savings glut” help explain the trade deficit?

e) Write a short "elevator conversation" in which you explain clearly to less informed people (on the elevator, in a few minutes) what a "trade deficit" really is.

Answer 1

a) A current account records the flow of goods and services in and out of a country, including tangible goods, service fees, tourism receipts, and money sent directly to other countries either as aid or sent to families.

A financial account measures the increases or decreases in international ownership assets that a country is associated with While,

The capital account measures the capital expenditures and overall income of a country.

b)A trade deficit occurs when the value of a country's imports exceeds the value of its exports—with imports and exports referring both to goods, or physical products, and services.

In short, a trade deficit means a country is buying more goods and services than it is selling.

c) The U.S. trade deficit, which has expanded significantly in recent decades, a priority of his administration. He and his advisors argue that renegotiating trade deals, promoting “Buy American” policies, and confronting China over what they see as its economic distortions will shrink the trade deficit, create jobs, and strengthen national security.

The reason for the deficit can be boiled down to the United States as a whole spending more money than it makes.

• More government spending, if it leads to a larger federal budget deficit, reduces the national savings rate and raises the trade deficit. A portion of the budget deficit is effectively financed through a rise in the total amount Americans borrow from abroad.
• The exchange rate of the dollar is important, as a stronger dollar makes foreign products cheaper for American consumers while making U.S. exports more expensive for foreign buyers.
• A growing U.S. economy also often leads to a larger deficit, since consumers have more income to buy more goods from abroad.

d)A global saving glut (also GSG, cash hoarding dead cash, dead money, glut of excess intended saving, or shortfall of investment intentions)is a situation in which desired saving exceeds desired investment.

The global savings glut hypothesis, which was popularized by Former Federal Reserve Chair Ben Bernanke more than 10 years ago, states (in basic terms) that the world is dealing with an excess of savings, and, as a consequence, insufficient investment. The theory is controversial and competing theories exist, but it does help to explain some of the issues faced by the world economy in recent years.

The negative impact of saving too much makes more sense when considered from an economic perspective. Spending, whether from consumers, businesses, or governments, ultimately drives economic growth. The major benefit of saving from an economic perspective is that it allows us to push spending forward, whether we’re “saving up” for something or planning for a time when our income levels might decline.