Economic Snapshot | Trade and Globalization

The dollar and the trade deficit


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Snapshot for October 6, 1999

The dollar and the trade deficit

The rising value of the dollar has made domestically produced goods less price-competitive and has contributed heavily to the recent surge in the U.S. trade deficit. In the past two decades, the United States has favored financial market interests in its important decisions regarding macroeconomic, monetary, and regulatory policies. Financial markets have especially benefited from the priority given to inflation control over other objectives of monetary policy as well as the promotion of financial market deregulation and liberalization of capital flows at home and abroad. These policy changes have had the effect of raising real interest rates in the United States while destabilizing foreign financial markets, making U.S. financial markets a magnet for investors from other countries. This influx of foreign funds has kept the dollar’s value high and has undermined the interests of U.S. producers of internation-ally traded goods and services.

The appreciation in the value of the dollar explains why U.S. products have suddenly become so much less competitive in real, inflation-adjusted terms, both at home and in foreign markets. The chart shows that, after a downward trend from 1990 to mid-1995, the dollar began to rise in value between mid-1995 and mid-1997, accelerating in its climb during the Asia crisis in mid-1997. Although the dollar has since stabilized, it has not fallen back to the levels of the early 1990s, when U.S.-produced goods and services were more price-competitive.

The impact of this increase in the dollar’s value is that U.S. producers of tradable goods find it harder to compete, no matter how advanced their technology or how productive their workforce. The dollar’s rise has made domestically produced products about 20% more expensive than other countries’ products over the past four years.

Source: Board of Governors of the Federal Reserve System.

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