Trade deficit

A trade deficit occurs when the value of what a country imports exceeds the amount of its exports. When this occurs, the country's domestic currency is flowing out to other countries. Depending on other variables, a prolonged trade deficit can result in a reduced exchange rate for a country's currency. When investors and governments in other countries hold large amounts of a country's currency, they can choose to sell these holdings, which results in a sharp decline in the exchange rate.

A trade deficit should theoretically be offset by trade surpluses over time, since declines in a country's exchange rate make its goods and services cheaper for foreigners to buy, thereby driving up demand and correcting the initial imbalance.