After months of crises the latest piece of economic news, which is quite encouraging is that the US trade deficit for the month of August has fallen 2.4 percent to $57.6 billion from $59 billion in July.This is the smallest since January according to the Commerce Department.
US exporters benefited from a weak dollar and strong overseas growth to notch up record exports of $138.3 billion.The decline in the deficit would have been larger but for the increase in oil prices.Significantly the deficit with China has dropped 5.3 percent to $22.5 billion.It seems that the efforts of the government in this direction are finally having some effect.This decrease has also been aided by the various recalls of Chinese made goods which affected their demand to some extent.
To appreciate the significance of this development it is necessary to understand why consistently rising deficits threaten to disrupt the US economy.A deficit as everybody knows arises when the value of goods and services exported is less than the value of the goods and services imported.In such a situation foreign countries and corporations are left holding dollars. Increasing deficits year after year imply that the supply of dollars with them also goes on increasing.The fear that is uppermost in everyone's mind is that a point will come when they may decide that it is no longer worthwhile to hold dollars, and they may decide to sell some of those dollars causing it to lose value sharply. This will lead to a spike in the prices of vital imports like oil for instance and place pressure on the US economy.In order to preserve the value of the dollar the US would have to increase interest rates which would affect economic growth, lead to unemployment and the entire vicious cycle would follow.
So far the US has been spared these consequences for some very simple reasons.The US economy was the only one which was large enough to absorb the huge surpluses generated by the oil exporting countries and countries like China and Japan.The US needed these dollars to finance its development needs as in recent times it has become a nation which saves less than it needs.So these trade surpluses have flown back to the US.Finally the US dollar has been a safe haven currency in an age of international turmoil.But now with the growth of the Eurozone economy and the rapid pace of development of the BRIC nations, coupled with a slowing of the US economy there is a real danger of the US dollar falling too far and too fast as people seek to shift to nations offering prospects of higher returns.
It is in this background that the decline in the US trade deficit assumes significance. Further declines coupled with a growing economy will result in a drastic reduction of the trade deficit as a percentage of GDP which will be desirable for the health of both the US as well as the global financial system.