Trade deficits and currency depreciations

The Economist has a very relevant feature this week on the connection between countries running sizeable current account deficits on their balance of payments and movements in their exchange rate. The carry trade has been a factor in recent years acting to prevent exchange rate depreciations from helping some countries to adjust their current account deficits downwards but now some of the biggest deficit countries including the UK are experiencing notable exchange rate weakness.

“Current-account imbalances are once again exerting a powerful influence over currencies. The chart shows that the weakest currencies this year have been in countries with deficits, from Britain to South Africa.”

This is not to say that exchange rate depreciations on their own are sufficient to make much of a dent in the UK trade deficit for the root causes are supply-side in nature. But it will be interesting to see how much of an improvement we see in the UK trade figures over the next year or so as the combined effects of a sharp consumer slowdown and a weaker currency start to make an impact.

The Economist article is here