Trade Deficit

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1. Is Warren Buffett’s decision to bet against the dollar a good one? Why or why not?
A: Yes. He is betting that trade deficit will not be fixed and American’s bad habit of borrowing from abroad to pay for today will not stop. This is caused by Americans spending far more on imports than they are earning from exports. To finance this trade deficit, the U.S. borrows from abroad. Also, the U.S. government is spending more than it takes in from taxes. The budget deficits widens the gap between the national income and national savings and increases the deficit in the current account by requiring more borrowing from abroad. The widening current deficit puts pressure on U.S. currency in the financial markets. As long as Americans are
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current account deficit is financed by foreign capital inflows. These increasing direct foreign investments in the United States cannot continue without limit. This process cannot continue indefinitely since in continued, foreigner investors will eventually hold a larger share of American assets in their portfolios than they desire because there is a limit to the appetite for US. assets. The portfolio will be so large that foreigners will worry about the ability of the United States to service and pay back this debt. Already, foreign investors own 19.4% of U.S. debt. (Lindeman, 2011) The continual widening of the current account is a problem because some day foreign investor will reach its limit in financing U.S. current account deficit. When foreign investors stop buying US debt and we still have a current account deficit, U.S. can have following problems: * US interest rates will need to rise to attract enough investors to buy the debt. These higher interest rates will reduce demand in the economy. * If capital flows can’t be attracted then the dollar will continue to devalue further. This is caused by oversupply of dollar overseas who now wants to get rid of the dollar and reallocate. Trying to sell their dollar, the price needs to fall, thus the price of dollar. The fall of dollar can cause inflationary pressures and interest rates may need to rise to stabilize the dollar. * If the dollar increases due to overwhelming
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