Continuing my series of examining the effect of exchange rate (or lack thereof) on trade imbalances, I’ll now examine South Korea, America’s 7th largest trading partner (year-to-date in 2010).
Thus far, we’ve found that in trade between the U.S. and less densely populated nations, fluctuations in currency exchange rate has the effect that economists would predict: a rise in the value of the dollar worsens our balance of trade while a falling dollar improves it. However, in trade with more densely populated nations, there is no such effect. In fact, if anything, the data indicates an opposite effect – that a falling dollar is more likely to yield a worsening in the balance of trade.
The data for South Korea is an exception, but with a huge asterisk. Here’s the chart showing the U.S. balance of trade with S. Korea, a nation almost 15 times as densely populated as the U.S., and the dollar-won exchange rate:
There is a slightly positive correlation between exchange rate and the balance of trade. But some closer examination casts doubt on the effect. The effect was strongest during the period of ’93-’98. However, during most of that period, the won was effectively pegged to the U.S. dollar. In 1997, the IMF (International Monetary Fund), forced S. Korea to end that peg. That, along with a simultaneous depegging of the Thai baht from the dollar and an economic collapse in that country, caused the East Asian financial crisis in 1997, an event that briefly threated global economic collapse. The dollar soared vs. the won and resulted in a dramatic worsening in the balance of trade with S. Korea, turning a small trade surplus into a huge trade deficit.
During the decade that followed, a year-by-year analysis shows a slightly positive correlation between balance of trade and exchange rate. But when that decade is taken as a whole, a falling dollar actually had no effect in stemming the increase in the U.S. trade deficit with S. Korea.
So this piece of data bucks the trend in the relationship that was taking shape, where the effect of exchange rate on the balance of trade decays as the population density of trading partner rises. But I’ve included an asterisk for S. Korea, since the exchange rate was affected by unusual forces.
However, the trade data with South Korea correlates perfectly with my population density theory. We have a large trade deficit with S. Korea, just as it would predict.
Here’s the correlation score sheet and chart:
The population density theory continues to be a far better predictor of balance of trade than the exchange rate theory.
Next up will be U.S. trade with France, America’s 8th largest trading partner year-t0-date in 2010.
Exchange rate data provided by www.oanda.com.