BPEA | 1990 No. 2

U.S. Current Account Adjustment: An Appraisal

Robert Z. Lawrence Peter Hooper
Peter Hooper Managing Director, Chief Economist - Deutsche Bank Securities

1990, No. 2

SINCE THE DOLLAR’S decline in 1985, opinion has been divided about prospects for the U.S. trade deficit. Pessimists have argued that the weak industrial competitiveness of the United States and the barriers against its exports, particularly in Japan, prevent the U.S. trade deficit from significantly responding to the dollar’s depreciation. These views reject other economists’ explanations of the trade deficit, which have emphasized the role played by macroeconomic factors rather than foreign protectionism and industrial policies. Some other “pessimistic” economists have argued, on empirical grounds, that the response of the trade deficit would be small because importers have been unusually willing to absorb the impact of the weaker dollar in their profit margins. Still others have argued, on theoretical grounds, that the strong, pre-1985 dollar itself could have damaged the economy’s capacity to respond to the eventual fall of the exchange rate-a phenomenon known as “hysteresis.” I Hysteresis occurs, according to these views, because the appreciation of the dollar forces U.S. firms to reduce capacity and induces foreign firms to invest in distribution facilities in the United States. Therefore, when the dollar returns to lower levels, U.S. firms have less industrial capacity than when the cycle began while foreigners remain entrenched with “beachheads” in the U.S. market. Moreover, once foreigners have entered the market, U.S. firms find their own pricing power permanently reduced.