Since April’s Group of Seven meeting called for greater exchange rate flexibility, the Federal Reserve’s broad trade weighted dollar index has weakend by just 1.6 per cent. US growth, however, appears to be slowing faster than expected. Can the G7, which meets later this month, take a more sanguine view of currencies in the hope that slowing US demand will shoulder the burden of current account adjustment?

Unfortunately not. With the US deficit at 6.4 per cent of gross domestic product, the reduction in demand needed to dent it is considerable. Total US demand for tradeable goods, including net imports, is equivalent to over 30 per cent of GDP. To halve the current account deficit, demand for tradeables would have to fall by a tenth. In the absence of exchange rate movements, which represent relative price changes between tradeable and non-tradeable goods, overall demand in the economy would have to fall by this unacceptable amount.