The trade deficit peaked at 6% of gross domestic product in 2006. It fell during the recent recession to about 3% of GDP. While this decline has quieted those who support protectionism, and allowed the Obama administration to declare that there are no countries manipulating currency values, protectionism is never far from the political front burner.
Given all the dollar depreciation of the past several years (although not recently), along with the traditional lag time of two-plus years for changes in exchange rates to influence trade flows, the deficit may shrink further. However, the strength of the recovery is reversing this trend, rapidly restoring the purchasing power of American consumers and businesses luring in more foreign capital. As a result, the trade deficit will probably remain near current levels for the next year or so.
But this fear about the deficit ignores a major reason for it. Ultimately the U.S. trade deficit is a byproduct of an attractive investment climate. Foreigners with assets to invest often need to worry about the risks of exposing those assets to a local banking system that makes ours look like a pillar of strength. Just look at Thailand’s populist upheaval, or the pressure for Greece to abandon the euro and devalue. No wonder central banks and other investors view U.S. investments as preferable, even if investment returns (in dollars) are paltry.