These exchanges, or transactions, fall under two categories: A Current Account and a Capital Account.
The flow of goods, services, and money in and out of the United States is recorded in the current account. When national expenses exceed national income or budget, meaning the current account is "overdrawn," it is referred to as a trade deficit.
The US finances its current account deficit by issuing securities and bonds. Since fluctuations in the BOP also affects the value of the US dollar, the Federal Reserve uses a managed floating system by occasionally intervening to control fluctuations in the exchange rate.
Daniel Griswold, in his 1998 trade policy analysis, states "No aspect of international trade is understood less than America's perennial trade deficitTrade deficits reflect the flow of capital across international borders, flows that are determined byhow much people save and invest. This renders trade policy1 an ineffective tool for reducing a nation's trade deficit[since] since trade deficithas virtually nothing to do with trade policy."
Griswold explains that a country that has more investments than savings, such as the United States, must bring in capital from overseas through a capital account surplus. These foreign investments enable Americans to buy more goods and services even if they produce less, bridging the gap through a trade deficit.
Since the mid-70s, the US has had a yearly trade deficit, reaching $100 billion in 1984 and over $150 billion in 1987. In 1991, the trade deficit dropped to $31 billion, but has been increasing since then, reaching over $190 billion2 in the fourth quarter of 2005 (BEA, 2006). Trade deficits have been blamed for "unfair" foreign trade barriers, unemployment, and the "decline" in international competitiveness. However, the American economy has actually expanded in direct proportion to the trade deficit's waxing and waning over the years as shown in Figure 1.
Figure 1. Trade balance and US recessions (Griswold)
The booming US economy and the strength of the US dollar facilitates the influx of foreign goods and services, not to mention foreign capital, into the country. This signifies investor confidence, the purchasing power of the American consumer.
International Investment Position
According to the Bureau of Economic Analysis (2005), the US International Investment Position (IIP) by the end of 2004 was approximately -$2,500 billion. This is advantageous to the US since it means that the amount of foreign investments in the US exceeded the amount of US investments overseas. Foreign investors bought US Treasury securities and corporate bonds; and the rise of most foreign currencies against the US dollar increased the financial value of US-owned assets in other countries, particularly of US-owned foreign stocks and direct investment.
America's trade deficit demonstrates its appeal to foreign investors. When the flow of foreign investment into the US rises, there is a corresponding increase