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short essays and reports on the economic issues of the day
2009 ■ Number 31

Asset Prices and Their Effect on the
U.S. Trade Balance
Luciana Juvenal, Economist
he U.S. trade deficit has steadily widened since the
example, U.S. equity prices rose by almost 340 percent
early 1990s, reaching a level of about 7 percent of
between 1990 and 2000 before losing about one-third of
gross domestic product (GDP) in 2006. The “trade
their value in the first two years after the dot-com crash.
balance” is the difference between a country’s exports and
Similarly, housing prices increased by around 130 percent
imports. A deficit implies that a country imports (buys from
between 1990 and 2007 with a marked increase from the
the rest of the world) more than it exports (sells to the rest
early 2000s until 2007. Moreover, after the subprime crisis
of the world). When a country has a trade deficit, it sells
that began in the summer of 2007, sharply declining asset
its assets—bonds, equity, or direct investment—to the rest
prices have brought about an improved trade balance.
of the world. In effect, the country is borrowing to finance
current consumption. Eventually, these sold assets produce
Pronounced cycles and booms in asset
income for their new owners in the rest of the world. This
income is paid in dollars, but the rest of the world uses those
prices have usually accompanied
dollars to buy either more assets or goods and services.
widening trade deficits.
Therefore, future U.S. exports must increase to repay the
holders of U.S. assets so trade deficits do not grow forever.
What links exist between asset prices and the trade
What factors can push the U.S. trade balance to a more
balance? Rising asset prices are presumably linked to trade
sustainable level?
deficits because they increase household wealth and spendSome economists have suggested that a large trade deficit
ing, as well as make investment cheaper for firms because
should cause the dollar to depreciate. The underlying logic
is that a cheaper dollar will lower the price of
U.S. exports and raise the domestic price of
U.S. imports. Thus, the United States would
Asset Prices and the U.S. Trade Balance as a Percentage of GDP
import less and export more, which would
Percent of GDP
return the trade balance to a more sustainable
level. Recent analysis, however, suggests that a
Trade Balance (left axis)
Housing Prices (right axis)
dollar depreciation is unlikely to close the trade
Equity Prices (right axis)
gap.1 A problem occurs because the prices of
many U.S. imports are denominated in dollars,
so the prices that U.S. importers pay are rela–3
tively unchanged after a depreciation. As a
result, the demand for imports does not decline
much, at least in the short term. Although
exports are more responsive to exchange rate
changes, it is unlikely that an increase in exports
is sufficient to close the entire trade gap.
What other forces could drive the trade
1990:Q1 1992:Q1 1994:Q1 1996:Q1 1998:Q1 2000:Q1 2002:Q1 2004:Q1 2006:Q1 2008:Q1
balance? As the chart shows, pronounced
SOURCE: Bloomberg, Bank for International Settlements, and International Monetary Fund.
cycles and booms in asset prices have usually
accompanied widening trade deficits. For


Economic SYNOPSES

Federal Reserve Bank of St. Louis

they can finance it by issuing equity.2 Conversely, weakening
asset prices might be associated with lower spending, and
hence, lower demand for imports.
In conclusion, a large U.S. dollar depreciation could be
a key driver of the trade balance adjustment, but recent
analysis has questioned its effectiveness. Given the strong
links between equity and housing prices and the trade balance, moderating U.S. asset prices could serve as an alternative mechanism to sizably adjust the trade deficit. ■


Goldberg, Linda and Wiske Dillon, Eleanor. “Why a Dollar Depreciation May
Not Close the U.S. Trade Deficit.” Federal Reserve Bank of New York Current
Issues in Economics and Finance, June 2007, 13(5), pp. 1-7;

2 Fratzscher, Marcel; Juvenal, Luciana and Sarno, Lucio. “Asset Prices, Exchange
Rates and the Current Account.” Working Paper No. 2008-031, Federal Reserve
Bank of St. Louis, August 2008, revised May 2009;

Posted on July 6, 2009
Views expressed do not necessarily reflect official positions of the Federal Reserve System.