$US-DEM/EUR Exchange Rate vs U.S. Balance of Trade with Germany

Continuing our series of examining the effect of exchange rate on the balance of trade between the U.S. and its major trading partners, we now turn our attention to Germany.  Previously, we have seen that the effect of changes in the exchange rate on the balance of trade has been as economists would predict when the U.S. is dealing with countries roughly equal in population density or less densely populated – countries like Australia, Canada, Brazil and Colombia.  When the dollar falls, our balance of trade improves, and vice versa.  However, the predicted effect seems to break down when dealing with nations far more densely populated – nations like Japan and China.  Changes in the currency exchange rate seem to have no effect whatsoever or, if anything, yield the opposite effect.  That is, a decline in the dollar is more likely to result in a worsening of America’s balance of trade.  Or more likely, a worsening trade deficit yields a decline in the dollar, as economists would predict, but that decline is powerless to offset the effects of population density disparity and reverse the deficit, contrary to what economists would predict.

So let’s see what happens in America’s trade with Germany, another nation far more densely populated than the U.S., by a factor of 7.  Here’s a chart of the U.S. balance of trade with Germany vs. the exchange rate between the dollar and the Deutschmark (prior to 1998) and the dollar and Euro (following the adoption of the Euro in 1998). 

$US-DEM&EUR Rate vs Balance of Trade

In the case of Germany, there is no correlation, positive or negative, whatsoever.  Exactly 50% of the time, the balance of trade responded as predicted by economists in response to changes in the exchange rate.  But the other 50% of the time, changes in the exchange rate yielded the opposite result.  And look at the changes over the full period of time for each currency.  From 1990 to 1997, a small 7% rise in the dollar (from 1.61 DEMs to 1.73 DEMS) resulted in a 62% worse trade deficit – much worse than the small rise in the dollar would predict.  But from 1998 through 2009, a 21% decline in the dollar from .92 EURs to .727 EURs yielded only a 7.6% improvement in the trade deficit.  By far, most of that decline in the deficit was due to the global economic crisis that took hold in late 2008.  If we take away 2009 trade results, a 21% decline in the dollar actually resulted in a 40% worse trade deficit with Germany.  Were it not for the global economic crisis in 2009, we would conclude that the effect of a falling dollar is actually contrary to what economists predict. 

Here’s an update of the correlation tracking mechanism, with these results for Germany now included:

Theory Correlation Score

As you can see, a trend is taking shape.  When dealing with countries of similar population density, the correlation score tends to be greater than .5, indicating that changes in exchange rate produce the changes in trade balance that ecnomists predict.  But, when the trading partner is more densely populated (and the break seems to occur at about 2.0, when nations are at least twice as densely populated as the U.S.), the effect breaks down, and a weakening dollar has virtually no effect on reversing trade deficits. 

On the other hand, my theory of the effect of population density on per capita consumption and on trade imbalances has accurately predicted in all but one case so far (trade between the U.S. and Colombia) whether the trade imbalance would be a surplus or deficit. 

Next up:  Mexico.

*****

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

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7 Responses to $US-DEM/EUR Exchange Rate vs U.S. Balance of Trade with Germany

  1. MikeF says:

    Pete,

    As we have discussed, currency valuations affect the wealth of billionaire currency traders far more than they do trade balance between nations. Trading currency for profit rates right up there with Collateralized Debt Obligations and Credit Default Swaps. Currency manipulation is nothing more than a legal con.

    Several elements must be taken into consideration when we discuss trade imbalance. Free trade between grossly disparate nations can never work regardless of currency valuation. Overpopulated export-dependent, resource-poor nations such as Japan are toast. South Korea will soon join that same club.

    The U.S. and Canada have two choices, take drastic measures to reduce our population while retrenching into the same domestic economy model that built this nation or watch Middle America fall to abject poverty while attempting to gain parity with the third world.

  2. Peteopolis says:

    MikeF,

    And their response is: “Innovate or die!”.

    And my response is “Where are the royalty payments for the past innovations?”.

    The innovators get fired by the investment banks. Thats what they get.

  3. Robert says:

    Pete,

    I came across a documentary about the population problem in Australia put together by Dick Smith called “Dick Smith’s Population Puzzle”. It is too bad the U.S. does not have someone of his standing and influence doing the same thing here.

    http://www.abc.net.au/tv/populationpuzzle/video.html#top

  4. MikeF says:

    Robert,

    We have hundreds of “Dick Smith’s” in the U.S. who work tirelessly to pierce the vale of stupidity that resides among our populous. Professor Albert Bartlett, Frosty Wooldridge, former Governor Dick Lamm, Roy Beck, and the list is endless.

    To get any message out there must be willing listeners. We sorrowfully lack that element in the United States. Not until there is great pain will the masses wake up from the American Dream that was built on the impossible premise of infinite expansion in a finite environment. That dream will soon turn out to be our worst nightmare.

    • Pete Murphy says:

      Or until the field of economics uncurls from the fetal position it struck after the seeming failure of Malthus, looks beyond macroeconomic growth and once again opens its collective mind to the economic ramifications of population growth. If we had economists warning that it will only yield rising unemployment and poverty, we’d see real change in a hurry. But, alas, Mike may be right. The closed mindedness of economists may doom us to that reality.

  5. Robert says:

    Mike,

    You are correct about the lack of willing listeners. Belief in growth is the most popular religion in America. It is too bad that some of our billionaires in this country such as Paul Allen, Bill Gates or Warren Buffet won’t step up and try to make a difference as a few billion in advertising and film
    could make a real impact. My fear is that even when the nightmare hits, it will still take a long time for the growth paradigm to end.

  6. Mark Hall says:

    Pete:

    As you have been uncovering with your series, trade deficits revolve more around demographics and economic policy than exchange rates.

    When it comes to globalization, free trade and the thirst for cheaper labor and products from developing nations, some countries are much better at “balancing” free trade with domestic growth or stability.

    When I compare the trade ratios of four Euro zone countries (Germany, France, Spain and the U.K.)and the U.S. as it relates to five developing countries (China, India, Thailand, Indonesia and Vietnam), it becomes very easy to identify (a pattern emerges) those countries (Germany and France) in which the “government controls free trade and the economy” from those countries (Spain, U.K. and the U.S.) in which “free trade apparently controls the government and the economy”.

    * Information obtained from U.S. Census Bureau and Eurostat.

    2009 Import to Export Ratios with China:

    1.26 to 1.0 (Germany)
    2.26 to 1.0 (France)

    4.26 to 1.0 (U.S.)
    5.34 to 1.0 (U.K.)
    6.10 to 1.0 (Spain)

    2009 Import to Export Ratios with India:

    0.57 to 1.0 (Germany)
    0.96 to 1.0 (France)

    1.29 to 1.0 (U.S.)
    1.42 to 1.0 (U.K.)
    2.06 to 1.0 (Spain)

    2009 Import to Export Ratios with Vietnam:

    1.31 to 1.0 (France)
    1.67 to 1.0 (Germany)

    3.95 to 1.0 (U.S.)
    4.84 to 1.0 (U.K.)
    6.61 to 1.0 (Spain)

    2009 Import to Export Ratios with Thailand:

    1.05 to 1.0 (Germany)
    1.12 to 1.0 (France)

    2.50 to 1.0 (U.K.)
    2.70 to 1.0 (Spain)
    2.76 to 1.0 (U.S.)

    2009 Import to Export Ratios with Indonesia:

    0.99 to 1.0 (France)
    1.53 to 1.0 (Germany)

    2.53 to 1.0 (U.S.)
    3.49 to 1.0 (U.K.)
    8.03 to 1.0 (Spain)

    If we are to ever again be prosperous as a nation, we have to create and/or re-create sufficient, good paying jobs.

    To do this, our government HAS TO actually regain control of our economy.

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