11.j Balance of Payments - impact to currency during trade deficits

CFA Level II Economics
#1

Flow supply/demand mechanism. Current account deficits in a country increase the supply of that currency in the markets (as exporters to that country convert their revenues into their own local currency). This puts downward pressure on the exchange value of that currency.

I’m not sure I understand what they’re trying to say literally, nor the strategic takeaway. So let’s take USA vs China which has a trade deficit on the U.S. side. Is the book saying that:

  1. Chinese manufacturers produce goods that sell in the USA for U.S. dollars, not Chinese Yuan.

  2. Chinese people, once they capture the US dollars, convert that into Chinese Yuan.

  3. This devalues the USD in the USD: Yuan exchange ratio because there is an abundance of USD and a shortage of Yuan?

#2

Yes.

#3

Okay, but then why isn’t the opposite a counterbalancing force, i.e. since more goods are being purchased in the USA, the need for USD is higher, so the demand for USD increases the value?

#4

Are more goods being purchased in the USA? What makes you think so?

#5

Well the built-in assumption of the trade deficit is that Chinese people are now selling more goods to U.S. consumers than previously. Are you suggesting that these new sales are replacing purchases that would have been made from US manufacturers, so the demand for USD dollars remains stable?

#6

I’m suggesting that we have no evidence to think otherwise.

#7

Thanks again, S2000

#8

My pleasure.