Unfortunately when the US dollar weakens, the Chinese currency comes along for the ride. This means the trade imbalance between China and the United States will never correct unless the US simply stops buying Chinese goods. At the minimum in a US dollar devaluation, the relative value of Chinese goods will remain the same to US consumers. At the maximum, US consumers will turn more to Chinese goods as these good relative value to other countries will be cheaper. Should the US dollar continue to weaken, we might see our trade deficit with China go up and our deficit with the rest of the world going down.
Oh wait, this is already happening! The U.S. trade deficit with China shrank a tiny amount in August (to $20.23 billion from $20.42 billion). However, the U.S. trade with the euro area dropped to $4.32 billion from $6.72 billion and the deficit with Canada fell to $1.51 billion from $2.09 billion.
According to Richard Fisher, president of the Federal Reserve Bank of Dallas, "Foreign exchange markets are manic-depressive mechanisms just like every other market I've ever operated in. You have to be careful not to read too much into short-term movements. If we get it right, meaning if we get our economy back up and we don't do it with any risk to price stability on the downside or the upside, then I think the dollar will be fine." Since the US dollar index has been declining since mid-2002, one wonders what Fisher's medium term time frame encompasses? The Civil War?
This year, the greenback is sinking quickly (-15% US dollar index from March) under twin burdens of the Federal Reserve's QE program and the Obama administration's fiscal policies. It should not be a surprise to anyone that our major trading partners and major US dollar reserve holders are expressing dismay and concern over these policies. It should not be a surprise that they are attempting to do something about it via verbal warnings to the US over competitive devaluations and by discussing alternative reserve currencies.
It would be a major surprise if anyone in the US government did anything about it.