Understanding Trade Deficits and Capital Flows

The U.S. current account deficit, primarily driven by trade, is offset by a capital account surplus where foreign investment exceeds U.S. investment abroad. This dynamic is linked to the strength of the U.S. dollar, which tends to rise due to the high demand for U.S. assets. A strong dollar negatively affects U.S. exports by making them more expensive overseas, while simultaneously encouraging imports. This interrelationship illustrates how trade deficits may reflect underlying economic vulnerabilities, particularly in the manufacturing sector.