What is a Trade Deficit

In the economic world, a trade deficit is the economic measure of the negative difference between a country’s imports and its exports. If a country’s imports are more than its exports, then there is a trade deficit. A trade deficit is be simply calculated by subtracting the value of products being exported from the value of products being imported.

Trade deficits are not the optimal economic position many countries want to find themselves in. With the occurrence of a trade deficit, large amounts of a county’s monetary reserves are held by other nations. In such a situation, the currency of the country in question is at risk of spontaneous fluctuations which puts the value of a county’s currency at risk. For the past one decade, the United States has recorded a growth in the country’s trade deficit which has some economists worried as large portions of the U.S dollar are being held by foreign nations like Japan which could sell at any time. In such an eventuality, the resulting after-shock on the economy would be devastating. This is the chief risk of having a trade deficit.

The resulting situation displayed above is a direct result of increase in foreign debt. Trade deficit has caused the United State’s foreign debt to jump from $4.1 trillion to $5.1 trillion between 2004 and 2005 and with such vast increments, other nations will be less willing to hold on to the U.S dollar and other dollar denominated assets. When they pull away from a dollar induced position, the result will be a weakened dollar which will force the U.S to increase interest rates on their lending, sharply, so that they continue attracting foreign investors. With the high interest rates, the economy will be plunged into a recession, akin to the great recession of the 1920s. This situation can replicate itself in any country should they have a negative trade deficit.

Trade deficits are countered by paying out from the foreign exchange reserves and in case the deficit was beyond prudence, such payments may continue until the reserves are depleted. But at this point, the importing country will no longer be able to purchase more than what they export. This is what causes a sharp loss in currency value as well as inflation rates going through the roof. Small trade deficits are not considered a problem, but once it goes out of control, then there is a huge negative impact on the economy in question. The balance of trade or net exports gives us the relationship or difference between value of exports and imports in a given economy or country. This difference can be positive or negative.