Dollar-Yuan Exchange Rate vs. Balance of Trade

I recently promised a new series of posts that will explore the relationship (or more accurately, the lack of a relationship) between currency exchange rates and balances of trade.  It’s my contention that there is no relationship of any significance; that trade imbalances are much more heavily influenced by disparities in population density between the two trading partners.  In proving that trade balances in manufactured goods are driven by population density disparities, it’s just as important to disprove the usual suspects – currency exchange rates and low wages. 

This is the first post in this series that addresses exchange rates.  We’ll take a look at the dollar-yuan exchange rate and whether or not any relationship is evident between the exchange rate and our balance of trade with China.  The sole focus of the Obama administration’s trade policy has been badgering the Chinese to stop its practice of “pegging” the yuan to the dollar, allowing it to float freely and be determined by market forces.  Congress has threatened to pass legislation branding China a currency manipulator, potentially opening the door (under World Trade Organization rules) to punitive tariffs.  Economists have all agreed – China’s currency is undervalued by as much as 40%, and they have blamed this for America’s enormous trade deficit with China.

So even I was surprised when I compiled the data.  The dollar has steadily fallen since 2004 by 17% vs. the yuan.  Granted, the decline has been slow and has been managed by China, but the impression created by the Obama administration that the yuan has remained pegged at a fixed value is simply wrong. 

So here’s a chart of the exchange rate vs. the balance of trade:

Dollar-Yuan Rate vs Balance of Trade

If economists are right when they say that a falling dollar will improve our balance of trade, then we should see the trade deficit with China improve as the dollar declines.  But that’s not what we see here.  Instead, the trade deficit with China has actually worsened dramatically as the decline in the dollar-yuan exchange rate has progressed, worsening in four of the last five years.  It improved only in 2009.

Regarding the 2009 improvement, one might say that it has simply taken time for the reduced value of the dollar to take hold – that the balance of trade can’t improve until manufacturing capacity is rebuilt in the U.S. – something that might indeed take several years.  Such an explanation might hold water except for one very important fact:  the U.S. trade deficit with the entire world declined by 46% in 2009, thanks to the recession and its corresponding impact on global trade.  But America’s trade deficit with China fell in 2009 by only 15%.  In other words, were it not for the recession, it’s likely that our trade deficit with China would have substantially worsened. 

Therefore, if there is any cause and effect at all between exchange rates and balances of trade, this chart seems to indicate that a falling dollar is probably the result of a rising trade deficit.  The change in exchange rate is caused by the deficit, instead of the opposite cause and effect. 

It seems clear from this chart that those who pin their hopes on a falling dollar to reverse our trade deficit with China are barking up the wrong tree. 

But this is just an 8-year track record with one currency.  In future posts we’ll examine more currencies over a longer period of time. 

*****

Exchange rate data comes from the OANDA web site:

http://www.oanda.com/?srccont=breadcrumb

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2 Responses to Dollar-Yuan Exchange Rate vs. Balance of Trade

  1. Mark Hall says:

    Current “Exchange” value of Chinese Yuan compared to U.S. Dollar = $.1464

    Past, Current & Future “Stupidity” value of U.S. Domestic & Global Economic Policy = “PRICELESS”

    If the “PRICELESS” value of this stupidity could be measured, it’s current actual value would be very close to $13,000,000,000,000+ (Our national debt).

  2. Monita JoshiKhamkar says:

    Dear Sir,

    Very informative and helpful for beginers.
    Thanks , its very helpful
    Monita

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