Continuing my series that examines the correlation (or lack thereof) between currency exchange rate and its effect on the balance of trade between the U.S. and various nations, we now turn our attention to Mexico. Here’s the chart of currency exchange rate (between the dollar and the Mexican peso, or “MXN”) vs. the balance of trade between the U.S. and Mexico.
This is the strangest chart we’ve seen yet, for a lot of reasons. First of all, in 1993, Mexico devalued their currency by a factor of 1,000, lopping three zeroes from the value of the peso. Secondly, the North American Free Trade Agreement (NAFTA) went into effect at the beginning of 1994. The result is that a tidy surplus of trade with Mexico instantly vanished, to be replaced by a rapidly exploding trade deficit.
So, from 1990 through 2009, the American dollar actually soared by almost 5,000%, and our balance of trade went from surplus to a huge deficit. This is what economics would predict. However, when we do a year-by-year analysis, we find little correlation between exchange rate and the balance of trade. There were some years in which the dollar fell; yet the trade deficit continued to worsen dramatically. Exactly 50% of the time, the balance of trade moved as economists would predict in reaction to changes in currency valuation, while it moved in the opposite direction the other 50% of the time. For this reason, I’ve given the exchange rate between the U.S. and Mexico a score of “no correlation” on our correlation tracking chart:
This may not seem fair, since there seems to be a strong correlation when the whole 19-year time span is considered. A much stronger dollar coincides with a much worse balance of trade. But “coincides” seems to be a good choice of words because it seems to be nothing more than pure coincidence. The fact is that a long-term trend of deteriorating economic conditions in Mexico has continued to erode the value of their currency, in spite of their enormous trade surplus with the U.S., keeping wages depressed and exacerbating the trade imbalance. Under normal circumstances, such a large trade surplus should have resulted in rising wages in Mexico, eventually leading to the restoration of something closer to a balance of trade. But Mexico’s slow but steady backward march from developing nation to 3rd world status prevents normal economic mechanisms from functioning.
So Mexico lands right on the trend line that has been taking shape as we’ve added more countries to this analysis. The balance of trade with nations with a relatively low population density seem to respond as economists would predict to currency valuation changes, as evidenced by a correlation score greater than 0.5. But, for more densely populated nations, the correlation falls below 0.5 and there is no tendency whatsoever for trade imbalances to improve in response to a falling dollar.
Next up: the U.K.
Currency exchange rate data provided by www.oanda.com/