Thanks for your post. You write “ Therefore, when foreigners use their dollars to buy more US stocks or bonds, it automatically reduces US net exports of goods and services“. Without a currency adjustment, what’s the “ automatic “ mechanism that reduces US net exports?
This is a fantastic question and I'm happy to answer it because I wrestled with how much detail to include on this mechanism in the paper. I ultimately decided to simplify several technical concepts to maintain readability, but the underlying mechanics are crucial for understanding how trade and capital flows interact.
Let me explain the mechanism by starting from scratch. Consider a simple two-country world (U.S. and China) where initially no one owns foreign currency.
Chinese entities can acquire U.S. dollars in two ways:
1) Trade Chinese financial assets for U.S. dollars (a pure financial transaction that nets out in the balance of payments)
2) Trade Chinese goods and services for U.S. dollars
When Chinese entities receive dollars from selling goods and services to the U.S., these dollars must return to the U.S. in one of two ways: 1) Buy U.S. goods and services (which would balance trade flows) 2) Buy U.S. financial assets
If they use these trade-earned dollars to buy U.S. financial assets instead of U.S. goods and services, this creates an imbalance: China has exported goods without importing an equivalent amount, creating a trade surplus matched by a capital account deficit (accumulation of U.S. financial assets).
The "automatic" reduction in U.S. net exports occurs because dollars earned from trade but used to buy financial assets are, by definition, not being used to purchase U.S. goods and services.
Thanks for your post. You write “ Therefore, when foreigners use their dollars to buy more US stocks or bonds, it automatically reduces US net exports of goods and services“. Without a currency adjustment, what’s the “ automatic “ mechanism that reduces US net exports?
This is a fantastic question and I'm happy to answer it because I wrestled with how much detail to include on this mechanism in the paper. I ultimately decided to simplify several technical concepts to maintain readability, but the underlying mechanics are crucial for understanding how trade and capital flows interact.
Let me explain the mechanism by starting from scratch. Consider a simple two-country world (U.S. and China) where initially no one owns foreign currency.
Chinese entities can acquire U.S. dollars in two ways:
1) Trade Chinese financial assets for U.S. dollars (a pure financial transaction that nets out in the balance of payments)
2) Trade Chinese goods and services for U.S. dollars
When Chinese entities receive dollars from selling goods and services to the U.S., these dollars must return to the U.S. in one of two ways: 1) Buy U.S. goods and services (which would balance trade flows) 2) Buy U.S. financial assets
If they use these trade-earned dollars to buy U.S. financial assets instead of U.S. goods and services, this creates an imbalance: China has exported goods without importing an equivalent amount, creating a trade surplus matched by a capital account deficit (accumulation of U.S. financial assets).
The "automatic" reduction in U.S. net exports occurs because dollars earned from trade but used to buy financial assets are, by definition, not being used to purchase U.S. goods and services.