How To Trade Foreign Currency
How to solve current account/trade imbalances?
Ignoring fluctuations in foreign currency pricing for a minute, how would a country deal with a large deficit, in terms of domestic savings? It is said in order to improve deficits, one must increase domestic savings while encouraging domestic consumption, does improving one not make the other worse?
Well you are sort of right but you don’t fully understand what’s being argued. Ways mathematically to decrease a trade deficit include:
- buy more DOMESTIC PRODUCTS rather than foreign imports. That does not mean increase the consumption component of GDP, it means change that mix to increase domestic consumption — consumption of products produced domestically — at the expense of IMPORT consumption.
- increase savings while reducing consumption. You are right in that you can’t increase the ratio of savings AND increase the ratio of spending at the same time, because you can only either spend or save money, there is no 3rd option. When a country spends too much and saves too little, then foreign investment is required to make up for the lack of domestic investment in the economy (“savings” provides the money for “investment”.)
Foreign investment is the flipside of a trade deficit. A country that has a large trade/current account deficit has a large amount of capital inflows, or foreign investment. That’s required by the math of international trade. Economists typically say that foreign investment finances the trade deficit — although to me it seems clear that just the opposite is true, the trade deficit comes first and finances foreign investment.
Anyway, increasing domestic savings goes hand-in-hand with reducing consumption of foreign imports, which goes hand-in-hand with reducing the funds available to foreigners to invest in your country, which goes hand-in-hand with reducing the current account deficit.
All those things are entwined and you could argue the cause-and-effect, but that’s how things balance.
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