Effect of Exchange Rates on Trade with Brazil and Colombia

Continuing our series examining the relationship between currency exchange rates and balance of trade, we now take a look at trade between the U.S. and two South American countries:  Brazil and Colombia.  In 2009, Brazil was America’s 11th largest trading partner.  And, given Colombia’s small size, they’re no slouch either.  So how has the balance of trade between the U.S. and these two countries been affected by the exchange rate between the dollar, the Brazilian real and the Colombian peso?  Has a stronger dollar led to declining trade balances, or a falling dollar resulted in improved trade balances for the U.S., as economists would predict?

Here are the charts.

$US-BRL Rate vs Balance of Trade $US-COP Rate vs Balance of Trade

We’re starting to see a pattern here.  These charts are virtually identical, and both are virtually the same as the charts for Australia and Canada that we looked at earlier.  There’s a good correlation between exchange rate and trade balance.  When the dollar rises, our trade balance gets worse and when it falls, the trade balance improves.

So much for my claim that population density disparities is what drives trade imbalances and not exchange rates, right?  Not so fast.  Once again, although the value of the dollar vs. the real has affected the balance of trade with Brazil, the balance has consistently been in favor of the U.S., as the population density disparity theory would predict.

In the case of Colombia, a nation slightly more densely populated than the U.S., they’re an oil exporter, leaving them flush with American dollars to spend on American manufactured products.  (Not to mention their illicit drug trade dollars.)

What we need here is a method for keeping score, so I devised the following spreadsheet:

Theory Correlation Score

For each country we’ve examined so far, I went year-by-year to see if the balance of trade followed the exchange rate theory.  That is, did our balance of trade improve in those years in which the dollar fell from the previous year, and did it worsen in those years in which the dollar rose?  I then totaled the number of years in which the trade balance behaved as predicted by the exchange rate, and divided by the total number of years.  For example, in the case of Canada, the trade balance behaved as predicted in 12 years out of 19, a 64% correlation.  (See the notes below the spreadsheet explaining the methodology.)

As you can see, for each of the less densely populated nations we’ve examined so far – Australia, Canada, Brazil and Colombia (where the population density ratio is less than or close to 1.0), there has been either a positive or strongly positive correlation between the balance of trade with the U.S. and the rise and fall of the exchange rate.  But in the case of China, more than four times as densely populated as the U.S., there is a strongly negative correlation.  That is, the U.S. balance of trade worsens as the dollar weakens.

In every case except Colombia, America’s balance of trade has been exactly as predicted by the population density disparity theory.  In the case of Colombia, where their population density is nearly identical to that of the U.S., the population density disparity theory barely applies at all, since there is very little disparity.  Nevertheless, since the U.S. is slightly less densely populated than Colombia but enjoys a surplus of trade in manufactured goods, I’ve scored it as not correlating with my theory.

All in all, this has been pretty inconclusive so far.  But stay tuned.  Next up is Japan.


Exchange rate data provided by http://www.oanda.com/.


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