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Trade Deficit and Reserve Currency

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Explain the USA's large trade deficits with China and Mexico according to the Hecksher-Ohlin Theory.
Explain why and how do you think the US dollar became a "Reserve Currency".

Discuss your ideas on whether the particular trend in America's international trade has been good for the country. Give your reasons for your argument. What will happen to the US dollar's role as a reserve currency? Is this good or bad or does it not matter? Make sure you discuss and answer each point.

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This solution provides a paper discussing trade deficits and reserve currency.

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Trade Deficit

The large trade deficit of USA with China and Mexico can be explained as the higher volume of imports by USA in comparison of its exports to China and Mexico. It can also be described as the flow of USA's currency in the market of China and Mexico. The large trade deficit of USA with China and Mexico can be understood through the Hechscher-Ohlin theory, which explains the base of trade between two countries. This theory describes that if the major factor of production such as labor and capital are not available in same portion in two countries then they intend to trade goods with each other to achieve competitive advantage (Why Trade, 2006).

A large trade deficit of USA with China is because of the availability of a large amount of labor in China in comparison of USA. The foreign direct investment in certain industries and production is shifting from the industry of USA to Chinese industry, which is also one of the reasons for increase in trade deficit. The larger amount of trade deficit is accounted by electronics and electrical equipments due to highest level of FDI by the US firms in China. Most of the US companies are shutting down their business in US and shifting it in china to achieve competitive advantage of labor and capital, two measure sources of production. It is causing an increase in imports of USA from China and Mexico, while decreasing its exports to these countries (Bronfenbrenner, 2001). The difference in capital, labor and technology between USA and China is causing an increase in trade deficit due to ...

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