What effect does a trade deficit with China have on the value of the dollar under freely floating exchange rates?

When a country has a trade deficit with another country, it means that it imports more goods and services from that country than it exports to it. In the case of a trade deficit with China, there are a few important dynamics at play that affect the value of the dollar in a freely floating exchange rate system.

When the United States runs a trade deficit with China, it is effectively sending more dollars to China than it is receiving in return for its exports. This increase in the supply of dollars in the foreign exchange market puts downward pressure on the value of the dollar relative to other currencies. As U.S. dollars are exchanged for Chinese yuan to pay for the imports, the greater supply of dollars can lead to a depreciation of the dollar.

Furthermore, with a weaker dollar, American consumers and businesses may face higher costs for imported goods, while exports become cheaper for foreign buyers. This can eventually encourage more exports and potentially help to correct the trade deficit over time. However, in the short term, the immediate effect of a trade deficit leads to a depreciation of the dollar under freely floating exchange rates, as seen in this scenario.

Other potential outcomes, like a constant value or appreciation of the dollar, are unlikely because they do not take into account the