The trade deficit has been larger than May’s pot of red ink, but not by much.
The Commerce Department
announced today that total May imports exceeded exports by $63.8 billion. That amounts to $500 million deeper in the red from April’s trade tally. On the other hand, May’s deficit is below the all-time monthly low of $66.6 billion of last October.
Most of the trade deficit can be traced to the state of business in goods, such as industrial supplies, consumer goods, agricultural products and automobiles, as the chart below illustrates. The dollar-value of exports of these and other items in the aggregate have in fact been growing over time. For the 12 months through May, for instance, U.S. exports of goods rose by 12.9%. Impressive as that is, it falls short of the 13.4% increase in goods imports into America over those 12 months.

It’s a different story with services, a catch-all label that includes an array of items that the government labels business, professional and technical services, for instance. Whatever you call it, exports of services expanded by 9.8% for the 12 months through May, comfortably above the 8.8% rise in services imports.
But while the U.S. does a booming business in selling services overseas, it’s a relatively small part of the trade ledger, or so the Commerce Department tells us. The business of importing and exporting goods is several times larger, measured by dollar value, and so the U.S. posts a trade deficit.
These trends have prevailed for years, and so America continues to report a deficit in trade that, over time, continues to descend. Today’s trade report isn’t likely to change this secular trend. If anything, questions about what the ongoing trade deficit means for the U.S. economy will only loom larger after perusing today’s numbers.
Chief among the queries: What lies ahead for the dollar if the trade deficit continues to deepen? Billions of dollars hang in the balance, not to mention the U.S. economy and its financial system, depending on the answer.

For the moment, however, stability reigns supreme. Although the greenback took a beating in the spring, it’s been treading water for the last month, measured by the U.S. Dollar Index. But what’s true in the short term doesn’t necessarily hold fast in the long haul.
A widening trade deficit implies a falling dollar. Economics 101 suggests no less. Yes, the U.S. has become accustomed to living by a set of rules that don’t apply to nations elsewhere on the planet when it comes to international finance. But living beyond one’s means is invariably a temporary boon, or so history warns.
Ultimately, the fate of the dollar, and thus the American economy, turns on the sentiment in far-off capitals, starting with Beijing. Indeed, China reportedly held $925 billion in foreign exchange reserves in May–easily the world’s largest stash of foreign currencies in one country, and born of the Middle Kingdom’s extraordinary success at exporting goods, primarily to America.
The flip side of China’s reserves is America’s debt and deficit. The two are in fact intimately connected. The fear among some economists is that the imbalance will eventually unwind, casting turmoil across the U.S. economy in the process. In the meantime, the Chinese and other foreign countries, notably Japan, continue to hold large and growing hordes of dollars and equivalents. Why?
The latest of many attempts at finding an answer comes by way of a new IMF paper, appropriately titled: U.S. Dollar Risk Premiums and Capital Flows. The authors ponder the strange case of foreigners holding dollars in the face of mounting fiscal and trade deficits within America’s shores. Have overseas investors taken leave of their senses? Far from it, argue the authors, who assert that demand for greenbacks remains robust despite the risks because America offers something that’s otherwise missing in the global economy. As the IMF study explains,

The paper finds that the presence of negative dollar risk premiums (i.e. expectations of a dollar depreciation net of interest rate effects) amid record capital inflows could suggest that investors may favor U.S. assets for structural reasons. One possible explanation could be that the Asian crisis created a large pool of savings searching for relatively riskless investment opportunities, which were provided by deep, liquid, and innovative U.S. financial markets with robust investor protection. Moreover, the continued attractiveness of U.S. financial markets to European investors suggests that they offer a large array of assets, with different risk/return characteristics, that facilitate the structuring of diversified investment portfolios. Looking forward, this suggests that the allocative efficiency of U.S. financial markets could mitigate risks of a disorderly unwinding of global current account imbalances.