Continuing my series of examining the effect of exchange rate (or lack thereof) on trade imbalances, I’ll now examine France, America’s 8th largest trading partner (year-to-date in 2010). This study of exchange rates vs. the effect on balance of trade couldn’t be more timely, given the escalating currency war that now dominates economic news.
France is a nation whose population density is more than three times that of the U.S. and is actually much closer to the population density of China. Therefore, my theory of the effect of population density on per capita consumption would predict a trade deficit with France. And that’s exactly what we have. In fact, expressed in per capita terms, our trade deficit in manufactured goods with France in 2008 was almost exactly the same as our deficit with China. (It fell in 2009, along with the rest of global trade, thanks to the recession.)
But how has the deficit responded to changes in the currency exchange rate? Until 1998, when France joined the European Union and adopted the Euro as its currency, the French currency was the franc. So the following graph depicts changes in the value of each.
As you can see, in the 19 years covered by this data, the U.S. trade deficit responded to changes in the currency exchange rate as predicted by economists 11 times. That is, the trade balance worsened when the exchange rate rose (when the dollar strengthened), or improved when the exchange rate fell (when the dollar fell). However, overall, during this 19-year period, the net result is that the exchange rate with France remained basically flat. Yet, the balance of trade with France worsened dramatically. So, when examined on a year-by-year basis, the correlation between exchange rate and balance of trade gets a weak positive score of 0.58. But the overall effect during that 19-year period indicates that there has been an opposite effect. The overall trend has been toward dramatic worsening of the balance of trade between the U.S. and France, just as my population density theory would predict.
So here’s an update of the theory correlation chart with France included:
Again, the population density theory continues to be a far better predictor of balance of trade than the exchange rate theory. So far, of the 11 countries examined, there has been a strong correlation between exchange rate and balance of trade in only two cases – Australia and Colombia, both nations either less densely populated than the U.S. or about the same.
Next up will be U.S. trade with Taiwan, America’s 9th largest trading partner year-t0-date in 2010.
Exchange rate data provided by www.oanda.com.