Question

Other things equal, if the United States continually runs trade deficits, foreigners will own _______ US assets.

a. more and more

b. less and fewer

c. the same amount of

Short answer

The correct option is option (c): the same amount of.

Step-by-step solution

Implication of trade deficit 

Financing of the US trade deficit has resulted in a larger foreign accumulation of claims against US financial and tangible assets than the US claim against foreign assets.A trade deficit is financed by borrowing from the rest of the world, selling off assets, or dipping into official reserves.

However, trade deficits are a mixed blessing. The long-term impacts of the record-high US trade deficits are largely unknown.

Effects on foreigner’s assets

Some economists opine that foreigners will lose financial confidence in the US economy when there is a trade deficit. They will restrict their lending to American households and businesses andalso reduce their purchases of US assets. Both actions will decrease the demand for US dollars in the foreign exchange market and cause the US dollar to depreciate.

Other economists, however, downplay this scenario. Because when there is an increase in the current account deficit, US net exports will rise, and the overall impact on the American economy would be slight.

So, in the short run, the foreigner’s assets will rise when US assets are sold in the foreign market to meet the deficit; in the long run, the increase in US exports will counterbalance the outflow.

Thus, the net effect is zero, and the foreigners will own the same amounts of US assets if the United States continually runs the trade deficits.