Trade deficits occur when a country lacks efficient capacity to produce its own products — whether due to lack of skill and resources to create that capacity or due to preference to acquire from another country such as to specialize in its own goods, for lower cost or to acquire luxuries. The most obvious benefit of a trade deficit is that it allows a country to consume more than it produces. In the short run, trade deficits can help nations to avoid shortages of goods and other economic problems.
In some countries, trade deficits correct themselves over time. A trade deficit creates downward pressure on a country's currency under a floating exchange rate regime. With a cheaper domestic currency, imports become more expensive in the country with the trade deficit.
Consumers react by reducing their consumption of imports and shifting toward domestically produced alternatives. Domestic currency depreciation also makes the country's exports less expensive and more competitive in foreign markets.
Trade deficits can also occur because a country is a highly desirable destination for foreign investment. For example, the U. Foreigners must sell goods to Americans to obtain dollars. According to the U. Treasury Department, foreign investors held over four trillion dollars in Treasuries as of October Other nations had to run cumulative trade surpluses with the U.
The stability of developed countries generally attracts capital, while less developed countries must worry about capital flight. Trade deficits can create substantial problems in the long run. The worst and most obvious problem is that trade deficits can facilitate a sort of economic colonization. If a country continually runs trade deficits, citizens of other countries acquire funds to buy up capital in that nation. That can mean making new investments that increase productivity and create jobs.
However, it may also involve merely buying up existing businesses, natural resources, and other assets. If this buying continues, foreign investors will eventually own nearly everything in the country.
Trade deficits are generally much more dangerous with fixed exchange rates. Under a fixed exchange rate regime, devaluation of the currency is impossible, trade deficits are more likely to continue, and unemployment may increase significantly. According to the twin deficits hypothesis , there is also a link between trade deficits and budget deficits.
Some economists believe that the European debt crisis was caused in part by some EU members running persistent trade deficits with Germany. Exchange rates can no longer adjust between countries in the Eurozone , making trade deficits a more serious problem. The U. International Markets.
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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Economy Economics. Key Takeaways In the simplest terms, a trade deficit occurs when a country imports more than it exports. A trade deficit is neither inherently entirely good or bad. A trade deficit can be a sign of a strong economy and, under certain conditions, can lead to stronger economic growth for the deficit-running country in the future. Article Sources. Investopedia requires writers to use primary sources to support their work.
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Trade Deficit: What's the Difference? Macroeconomics What is a trade deficit and what effect will it have on the stock market? To answer this question recall that the trade deficit means that the United States is buying more goods and services than it sells abroad imports exceed exports.
Just like an individual or a firm needs credit to spend more than its income, the trade deficit requires financing by foreigners. Foreigners finance the trade deficit by lending to Americans or by investing in the United States buying property or businesses. However, at some future date, the trade deficit must turn into surplus, so that the foreigners get paid back.
For the trade deficit to turn into a surplus, imports must fall and exports must rise. One way this adjustment can take place is if the dollar depreciates, making imports more expensive for Americans and exports cheaper for foreigners. If trade deficits are sufficiently large and unsustainable, economists believe that they will be associated with a weakening dollar at some future date.
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