Wednesday, June 18, 2008

Managing Trade Surpluses and Foreign Reserves

Are trade surpluses and foreign reserves necessarily a good thing?

Some governments would think so. A huge trade surplus from exporting more than we import is taken as "making money" by accumulating reserves in foreign-denominated assets. In such a "favourable" situation, the tendency is to maintain the same exchange rate and "let the good times roll."

But a trade surplus situation occurs when the exchange rate is too low, which makes exports "cheap" to foreigners and imports "expensive" to locals. The exchange rate should be allowed to "appreciate" in order to reduce the rate of accumulation of foreign reserves.

What, after all, are foreign reserves? They are nothing more than just investments overseas, either in bank deposits, government bonds, other financial assets, real estate or businesses.

By "reducing the foreign reserves," the spoils from trade could be used to reinvest in the local economy and build its foundation for future growth. Accumulating foreign reserves merely create jobs abroad.


ctchoolaw said...

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etheorist said...

ctchoolaw: Thanks. I got carried away last night.