Analyze whether a dollar depreciation will improve the U.S. current account deficit - Essay Example

In other words, a nation is said to have a trade deficit if it is imports more than it exports. Such a situation will make a country a net debtor to the rest of the world. However, in some cases current account deficit may not necessarily a bad thing for the developing countries. Current account deficits will encourage the developing countries to increase its local productivity which will be useful for that country in the long run. According to the statistics available for 2004-2005, U.S. holdings of foreign assets are around $ 8 trillion whereas foreign holdings of U.S. assets are around $ 10.

7 trillion (Blanchard, n. d.p.6). In other words, United States is a debtor to foreign countries. The situation became worst in recent times because of the global financial crisis and the subsequent dipping US economy. The exchange value of U.S. dollar is a major parameter in increasing or decreasing the current account deficit of United States. When the exchange rates of US dollar increases, the current account deficits will also increase and when the exchange rates of U.S. dollar decreases, the current account deficits will also decreases.

In other words, current account rates and the value of the dollar have direct relationships. This paper analyses the US dollar depreciation and its effects on America’s current account deficits. . “The substantial depreciation of the U.S. dollar against the currencies of most industrial countries since early 2002 is presumably a manifestation of diminishing relative enthusiasm for U.S. dollar investments, at least where market forces operate without significant official involvement” (Mussa, 2007,p.4). Depreciation of dollar will discourage developed countries from investing in US dollars.

Earlier, most of the foreign organizations invested heavily in US dollars because of the perception that US economy will never be destroyed and the dollar value will never be decreased. However, the recent recession and the subsequent financial crisis happened in United States have forced others to change their opinion. Thus dollar started to depreciate against most of the industrial country currencies and the effective foreign exchange value of the dollar has been reduced considerably over the last few years.

Effective dollar depreciation, together with the relative strengthening of growth in other countries, has stabilized the U.S. external deficit when measured in real volume terms since late 2004; and the fourth quarter of 2006 will probably see a significant decline in this measure of the real payments deficit. The current account deficit as a share of GDP may also show a modest decline next year, especially if world oil prices remain below their average 2006 level (Mussa, 2007, p.4) “A depreciation of the U.S. dollar not only increases the dollar value of U.S. assets denominated in foreign currencies, but it also reduces the foreign currency value of U.S. liabilities, which are, essentially, all denominated in U.S. dollars” (International Financial Integration and the Current Account Balance, 2006, p.2). The