Why Trade Deficit Could Turn Boom Into Gloom

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What the dollar giveth, the dollar can also take away. And the value of America's coin of the realm may begin to assume greater prominence in the calculations of Fed chairman Alan Greenspan, as he computes the new record high in the U.S. trade deficit announced Wednesday. The $29.2 billion figure for February was almost $2 billion up from the previous month, and even though the oil-price hike was responsible for a substantial portion of the difference, the figure remains untenably high.

"Our imports increase as long as the economy grows," says TIME senior business writer Bernard Baumohl. "But there's certainly a concern that our exports are down despite the fact that Asian and European economies have begun to rebound. Maintaining the high deficit is dangerous because that means a huge debt, and if our creditors lose confidence in the U.S. economy and begin selling dollars, which drives down the value of the currency, that could spark a serious inflation threat." The best way to keep America's creditors sweet on the dollar is to make their returns more attractive by raising domestic interest rates.

But keeping the dollar strong could have a downside too: It keeps American exports pricey in the eyes of consumers in resurgent Asian and European economies. So Greenspan's best hope for reducing the trade deficit is that the interest rate increases he has made already may be enough to slow the U.S. economy and curb its voracious appetite for imports. "Interest rate hikes generally slow down consumption after about a year," says Baumohl, "and the Fed has been raising rates since last June, which ought to slow down imports." Overall, he says, Greenspan shouldn't be too worried. "It's fairly safe to say that the trade deficit may have peaked now that oil prices are falling and the U.S. economy is showing signs of slowing down."