Businesses and individuals in the United States buy from and sell to people and firms in other countries. If we buy more than we sell (that is, if we import more than we export), we are said to be running a foreign trade deficit. When trade deficits occur, they must be financed, and the main source of financing is debt. In other words, if we import $200 billion of goods but export only $100 billion, we run a trade deficit of $100 billion, and we would probably borrow the $100 billion.19 Therefore, the larger our trade deficit, the more we must borrow, and as we increase our borrowing, this drives up interest rates. Also, foreigners are willing to hold U.S. debt if and only if the rate paid on this debt is competitive with interest rates in other countries. Therefore, if the Federal Reserve attempts to lower interest rates in the United States, causing our rates to fall below rates abroad, then foreigners will sell U.S. bonds, those sales will depress bond prices, and that in turn will result in higher U.S. rates. Thus, if the trade deficit is large relative to the size of the overall economy, it will hinder the Fed's ability to combat a recession by lowering interest rates.
The United States has been running annual trade deficits since the mid-1970s, and the cumulative effect of these deficits is that the United States has become the largest debtor nation of all time. As a result, our interest rates are very much influenced by interest rates in other countries around the world—higher rates abroad lead to higher U.S. rates, and vice versa. Because of all this, U.S. corporate treasurers—and anyone else who is affected by interest rates—must keep up with developments in the world economy.
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