According to political theory, the current account deficit must eventually correct itself, and changing currency values is one way for it to correct itself. The theory works like this; America imports more than it exports, the cause of this is the low American savings rate, resulting from the huge level of American household borrowing (read as credit cards, debit cards, and mortgage refinancing) and the federal budget deficit. Not long ago foreign investors were eager to finance these annual trade imbalances with dollar asset, such as American Treasury bills and notes, corporate bonds and equity, however, foreign investors have lost their appetite for dollar denominated assets. This reduced demand for dollar denominated assets creates an imbalance in the supply and demand for dollars world-wide. It is a vicious cycle. As foreign investors sell their dollar denominated assets, the value of the dollar slides because of reduced demand, more foreign investors than sell their dollar denominated assets in reaction to the falling value of the dollar, and on and on. When the demand for dollars falls short of supply, as it is now, then either the value of the dollar must fall off, bond yields must rise to make dollar denominated investments more attractive to foreign investors. .
As the value of the dollar falls, according to theory, the products that America exports should become cheaper relative to other products. This change in price due to exchange rates makes American products more competitive with other international products in the international arena, closing the current account deficit. Kudlow and Kramer did not mention this benefit of a weaker dollar, but they did mention the President's push for China to allow its currency to "float.".
China's currency, the Renminbi, is currently pegged to the value of the dollar. This has preserve implications. As the dollar has fallen relative to the Euro, so to, has the Renminbi, making Chinese products cheaper in Euros along with American.
