Trade Deficit and Foreign Investment?

Question by sa1518: Trade Deficit and Foreign Investment?
“The U.S. runs a longstanding trade deficit — with imports outpacing exports — that is financed by foreign investment. Dollar weakness could inspire high investment returns that keep luring foreign investors and prop up the currency. ”

Can some please help explain the above two sentences? It was published in the WSJ this morning?

Thanks

Best answer:

Answer by Michael T
“The U.S. runs a longstanding trade deficit — with imports outpacing exports”

This means that the U.S. imports more goods and services from other countries. For example, in 2005, the US imported upwards of $ 700 billion worth of goods and services more than it exported. This is what is meant by a “trade deficit”.

“– that is financed by foreign investment.”

It’s important to realize that fundamentally, a US dollar is legal tender only in the United States. It has no intrinsic value for someone outside of the US except insofar as that person wants to buy something in the US, for can find someone will want to trade local currency for it because they want to buy something in the US.

The aforementioned trade deficit means that a lot of people outside of the US have a lot of US dollars that they have been paid for goods and services by Americans, but haven’t needed to pay for something from the US with. A couple of things can happen because of this:

(1) When someone who needs US dollars to buy something from the US turns up, a lot of people will chime up and say, “I have some US dollars I’ll trade you local currency for”, and the USD holders will have to compete for the trade with the USD needer. Supply and demand being what it is, more competition means the USD holders will have to exchange for a lower price in local currency. This is what causes currency devaluation.

(2) The holders of the USD can say, “the US stock market looks good, and the US government is offering treasuries that have an attractive interest rate, so I’ll take my extra USDs and buy some US stocks or treasuries”. This is the foreign investment referred to in the article.

Lately, less of (2) has been happening, and more of (1) has been happening, which is where a lot of the excitement lies.

“Dollar weakness could inspire high investment returns that keep luring foreign investors and prop up the currency.”

All this means is that with the dollar trading lower, foreigners can see US stocks as more of a bargain, especially if they hope for a modest dollar recovery. E.g. All of the sudden people with Euros can buy a lot more US stocks than they could before, and may very well do that.

In order to invest in the US stock market, though, they need to get some US dollars for their Euros, which means they have to trade someone for them. This increases the demand for US dollars, driving the price of them up.

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