S. net external debt from $3.3 trillion to $7.4 trillion. (Ibid. 6) Continued financing of the U.S. trade deficits by the rest of the world is also not without its long-term problems: the U.S. would accumulate so much debt over time that the ultimate cost of adjustment would become too high for the U.S. economy. Hence, all indicators regarding the sustainability of the U.S. trade deficit are blinking red, despite the brave face that the Bush administration puts on the issue. Is China the Source of the Deficit Problem?

The U.S. administration believes that the alleged under-valuation of the Chinese Yuan is the source of its deficit problems since there is a huge and growing trade imbalance between the U.S. exports and imports to China. The U.S. Senate recently passed a bill, threatening to slap a 27.5% tariff on Chinese imports if China does not revalue its currency within 180 days. ("Yuan Revaluation no help..." 2005) Most independent analysts as well as Chinese officials disagree with the contention that a revaluation of the Chinese currency would solve the U.S. deficit problem. China accounts for only 10% of the United State's total trade, so if there were a 10% revaluation of the Yuan, it would reduce the dollar's value by just 1%. ("Cock-a-Doodle Doo" 2005)

Possible Solutions to the Trade Deficit Problem fall in the value of the dollar is not enough for reducing the U.S. trade deficit sufficiently. The American government needs to borrow less by reducing its budget deficit and household savings in the U.S., which are among the lowest in the world, need to improve. The best way out according to most analysts is a gradual reduction in the U.S. trade deficit to sustain the U.S. And global growth rates. Roubini and Setser, in a recent paper, estimate that a measured reduction of the trade deficit by 0.5% annually would eliminate the deficit by 2015. (p. 6)

Conclusion general rule of economics holds that a persistent trade deficit results in depreciation in a country's currency. The U.S. has shown a persistent and rising trade deficit for the last several years, which has now reached alarming proportions. Although the U.S. economy and the dollar have been able to sustain the deficit due to status of the dollar as the sole global reserve currency and the need of export-oriented economies to support the American demand, strains are beginning to show. The dollar is losing value and the U.S. foreign debt is now almost 30% of its GDP. These are alarming signals for the U.S. And the world economies. Clearly, it is time to reverse the trend of the fast rising trade deficit by the adoption of appropriate policies.

References

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(12 April 2005). "It's more than the deficit, stupid!" [Online]. Political gateway. Available from: http://www.politicalgateway.com/main/columns/read.html?col=334[19 April 2005]
Cock-a-doodle-doo" (3 Feb 2005). [Online]. The Economist. Available from: http://internationalecon.com/MyCourses/News%20Stories/Economist_com%20%20China's%20exchange%20rate.htm[19 April 2005]

Mann, C.L. (1999). Is the U.S. Trade Deficit Sustainable? Washington D.C: Institute for International Economics

Moffatt, M. (n.d.) "The Trade Deficit and Exchange Rates." [Online]. Your Guide to Economics. Available from: http://economics.about.com/cs/analysis/a/trade_deficit.htm[19 April 2005]

The Passing of the Buck?" (2 Dec 2004) [Online]. The Economist. Available from: http://www.economist.com/finance/displaystory.cfm?story_id=3445928[19 April 2005]

Roubini, N. And Setser, B. (Nov 2004). "The U.S. As a Net Debtor: The Sustainability of the U.S. External Imbalances." [Online]. Available from: http://pages.stern.nyu.edu/~nroubini/papers/Roubini-Setser-U.S.-External-Imbalances.pdf[19 April 2005]

Ruby, D.A. (2003). "The Balance of Payments." [Online] Digital Economist. Available from http://www.digitaleconomist.com/bop_4020.html[19 April 2005]

Siddiqi, M. (April 2003). "Pressure Mounts on Dollar." African Business: 18+

Yuan revaluation no help to U.S. trade deficit problem." (10 April 2005). [Online]. People's Daily Online. Available from http://english.people.com.cn/200504/10/eng20050410_180317.html[19 April 2005]

or for that matter even a large, persistent trade surplus could be a sign of trouble

Due to a persistent positive balance of payments at the time, Japan had large amounts of money, which led to questionable overseas investment by Japanese in areas such as real estate. It also led to a domestic price spiral triggered mainly due to the protectionist measures adopted to create the trade surplus in the first place

The U.S. dollar has depreciated by more than 30% over the last 3 years

The Foreign Exchange Reserves (running into billions of dollars) are held by most counties in the form of U.S. Treasury bonds, short-term securities and dollar-denominated cash, i.e. fixed-term bank deposits or certificates of deposit. (Siddiqi, 2003, p. 18)

Larry Summers, a Treasury secretary under President Clinton, calls this the "balance of financial terror"

About 65% of the global foreign exchange reserves are currently held in U.S. dollars.

A significant fall in the value of the dollar would also mean the end of it status as the reserve currency with all the attached implications

Trade Balance