There has been a remarkable turnaround in the size of the monthly trade deficit in goods for the US economy. This prompted plenty of useful discussion in our AS macro class today when we revised government policies towards the balance of payments.

From monthly trade gaps of the order of $60bn or more, the difference between the value of imports and exports has narrowed to less than $30bn in the early months of 2009.

What is causing this dramatic reversal?

Firstly the depth of the domestic recession in the USA is causing a sharp fall in demand for imported goods.

Second the US is benefiting from the recent steep declines in the world price of oil and many other imported commodities. Check the chart below which tracks the cost for the USA of importing goods from China.

The story is essentially one where imports are contracting faster than exports and the result is an improvement in the net trade balance.

The external value of the US dollar measured on a trade weighted basis has been appreciating over the last nine to twelve months. Perhaps some of the reduction in the trade deficit is the consequence of an ‘inverse J curve effect’ whereby the trade position initially improves as a currency gains in value – with the price elasticity of demand for exports an imports both low in the short term.

The narrowing trade gap is a reminder that trade deficits are partially self-correcting – but that a slump in economic activity is a high price to pay for some movement towards resolving trade imbalances. It will not fundamentally change the momentum within the USA to adopt a wider range of protectionist strategies as a way of lifting domestic manufacturing production.