Reading from Mankiw's Principles

Prashanth Perumal posted on Fri, Nov 27 2009 6:56 AM

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Mankiw says:

"Trade policies do not affect the
trade balance. That is, policies that directly influence exports or imports do not alter
net exports. This conclusion seems less surprising if one recalls the accounting
identity:
NX = NFI =S + I.
Net exports equal net foreign investment, which equals national saving minus
domestic investment. Trade policies do not alter the trade balance because they do
not alter national saving or domestic investment. For given levels of national
saving and domestic investment, the real exchange rate adjusts to keep the trade
balance the same, regardless of the trade policies the government puts in place."

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To admit something first, I am very weak when it comes to studying the global economy with exchange rates. On that note, here we go!

My doubt is: If an import quota on imports from Japan restrains the amount of trade, and thereby the supply of dollars in the exchange market with Yen; the value of dollar appreciates when compared with the Yen. Now, won't this new exchange rate, assuming constant interest rates in the US and Japan and the interest rate in Japan being higher than in the US, which shows a stronger dollar actually encourage more American capital to move into Japan? That is, since each dollar now earns more Yens, shouldn't it be profitable now for more American capital to flow into Japan and thereby decrease the trade deficit of the US to a lower level than it would have been otherwise, and not 'to keep the trade balance the same' as is claimed in the quoted text?

In short, NFI(Net Foreign Investment), which is national saving minus domestic investment, doesn't seem to be a factor that is independent of trade policies(and hence trade policy is not removed from affecting the trade balance), no?