1. SOURCES OF THE U.S. EXTERNAL DEFICIT

The massive U.S. deficit of 1986-87 (see Figure 2) is explained by the conjunction of five factors:

1. The extraordinary overvaluation of 1980-85. The impact of the appreciation is apparent not only in the continuing $150 billion trade deficit, but it also shows in the massive increase in import penetration. Since 1980 import penetration in the consumption goods industry has increased from 7 to nearly 13 percent. For capital goods the increase is even more dramatic from 15 to 38 percent. (See Table 1)

   Table 1: Import penetration in the United States (percent of Domestic Demand)
   Year	Consumer Goods	Capital Goods
   1975	5.4	8.0
   1980	6.9	14.6
   1987	11.6	37.7

2. The sharp shift in trade with the newly industrialized countries (NICs). The U.S. has experienced a $60 billion shift in its manufactures trade with these countries since 1980.

3. The debt crisis has forced Latin American and other debtor countries to become net exporters to the U.S. market. Debt service requires foreign exchange and without new loans these resources can only be obtained by trade surpluses. The impact of the debt crisis is apparent from such data as Mexico's 40 percent manufacturing export growth in 1987.

4. The ten percent cumulative gap in aggregate expenditure growth over the period 1980-87 between the U.S. and other OECD countries which has meant a rapid growth of imports and only moderate export growth. (See Figure 3)

5. The emergence of a current account deficit has brought about a decumulation of external assets and now a growing external debt which generates a worsening current account deficit by its own debt dynamics.

Two questions now arise: Has the dollar depreciated enough? And since we conclude in the negative, why is the dollar not failing more rapidly? We now turn to these issues.