Don’t forget trade

The underlying U.S. trade deficit has shown some signs of stabilization, but the position is still precarious, with a deficit of $59 billion for August.

Initially, the deficit will continue to be inflated by high oil imports, and the U.S. current account deficit is liable to be at least 6.5 percent of GDP for 2005. The U.S. has, so far, avoided payment difficulties, but a deficit at this level is unlikely to be sustainable in the medium term.

China’s trade surplus with the U.S. has continued to rise, with a $22 billion shortfall reported for August, as imports from China continued to increase rapidly. There will be the risk of escalating trade tensions if the U.S. deficit continues to increase, with political pressure for stronger Asian currencies. These tensions would also increase the risk of wider selling pressure on the dollar.

There hasn’t been any official intervention in the currency markets over the past few months. The European and Asian central banks are, however, likely to discourage further strong dollar gains, especially as a weaker or at least a competitive dollar will be seen as an important element in narrowing global trade imbalances. Some dollar selling is also likely to be seen as an important element of medium term central bank reserve management.