Can the US trade deficit continue forever? Will there come a time when foreigners will become less likely to hold US denominated assets? Should such a time arrive, the US Federal Reserve will be forced to increase interests rates to prevent a collapse of the US dollar. This would be catastrophic to the US housing market and US economy as a whole.
Imagine an American counterfeiter who uses the fraudulent dollars to purchase Chinese goods. What would you say of such a scenario? Now imagine a US Central Bank that creates money "out of thin air", places that money into a bank, where upon the bank lends it to an American importer who then uses them to purchase Chinese goods.
Two things are obvious: 1) the Americans are getting a sweet deal ... so long as it continues, and 2) an emerging US trade deficit. What would occur should the Chinese cease to continue playing the game, or worse yet, use these dollars to purchase actual goods while the money still has value?
The US dollars have value so long as market participants attribute value to them. In 1934, the US Gold Reserve Act lowered the value of the US dollar from just over US$20 an ounce to US$35 an ounce. In 1933, the Franklin D. Roosevelt administration outlawed private ownership of gold except for the purposes of jewellery. In 1971, the Nixon administration closed the gold window to eliminate the concern that foreigners, whom could still exchange US dollars for gold, would completely drain the US gold treasury.
The US dollar has been on a turbulent journey ever since but the overall trend is clear - down. As long as the US Federal Reserve continues to inflate the money supply, how can the dollars ever increase in value?
The US trade deficit is not the CAUSE of an economic activity, it is the RESULT of monetary inflation by the US Federal Reserve. Protectionism, tariffs, unfair trading practices and other such political rhetoric surrounding the trade deficit will never work because they do not address the actual cause.
Then again, that never really was their purpose to begin with.
