What is a trade deficit and what effect will it have on the stock market?

By Investopedia Staff AAA
A:

A trade deficit, which is also referred to as net exports, is an economic condition that occurs when a country is importing more goods than it is exporting. The deficit equals the value of goods being imported minus the value of goods being exported, and it is given in the currency of the country in question. For example, assume that the United Kingdom imports 800 billion British pounds worth of goods, while exporting only 750 billion pounds. In this example, the trade deficit, or net exports, would be 50 million pounds.

Measuring a country's net imports or net exports is a difficult task, which involves different accounts that measure different flows of investment. These accounts are the current account and the financial account, which are then totaled to help form the balance of payments figure. The current account is used as a measure for all of the amounts involved in importing and exporting goods and services, any interest earned from foreign sources, and any money transfers between countries. The financial account is made up of the total changes in foreign and domestic property ownership. The net amounts of these two accounts are then entered into the balance of payments. (To learn more, see What Is The Balance Of Payments?, Understanding The Current Account In The Balance Of Payments and Understanding The Capital And Financial Accounts In The Balance Of Payments.)

In terms of the stock market, a prolonged trade deficit could have adverse effects. If a country has been importing more goods than it is exporting for a sustained period of time, it is essentially going into debt (much like a household would). Over time, investors will notice the decline in spending on domestically produced goods, which will hurt domestic producers and their stock prices. Given enough time, investors will realize fewer investment opportunities domestically and begin to invest in foreign stock markets, as prospects in these markets will be much better. This will lower demand in the domestic stock market and cause that market to decline.

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