While compiling the trade data for 2012 that’s been the subject of recent posts, I also gathered currency valuation data (from the OANDA web site) for each trading partner. In the past, I’ve done this with America’s largest trading partners and the data seemed to indicate that currency valuation plays no role in driving trade imbalances and that, if anything, the relationship between currency valuation and trade imbalance is the opposite of what economists suggest – that changes in currency valuation are actually the result of trade imbalances, not the cause. It’s an intriguing finding, one that merits a more exhaustive study. So I expanded it to include every country.
Effect of Changes in Currency Valuations, 2011-2012
Let’s begin with the changes in trade balances in 2012 from the previous year. Here’s a scatter chart that plots change in currency valuation vs. the change in the balance of trade in manufactured goods from 2011 to 2012: 2011-2012 Change. As you can see, this chart shows no correlation whatsoever. Most of the data points lie to the left of the zero line of the x-axis, meaning that most currencies of the world weakened relative to the dollar in 2012. Economists would predict that, therefore, most of the data points would lie below the zero line of the y-axis, indicating that our trade imbalance worsened in response. In fact, of the 110 nations who experienced a decline in their currency relative to the dollar, our trade imbalance worsened with 67 of them. It improved with 43 of them. That seems to provide some weak evidence that economists may be right.
But, wait. Not so fast. There are other indications that just the opposite may be true. For example, on average, other nations’ currencies declined vs. the dollar in 2012 by 8%. Yet, on average, our trade imbalance in manufactured goods actually improved by 14%. This seems to contradict the fact that, overall, our trade imbalance actually worsened in 2012. The reason for the contradiction is that these figures aren’t weighted according to nations’ sizes.
And if we look at the 20 nations with the biggest declines in their currencies, we find that our trade imbalance weakened with only nine of them.
Furthermore, although most nations’ currencies declined in 2012, not all of them did. Twenty-two nations’ currencies actually rose. Of these, our balance of trade improved, as economists would predict, in only eleven cases – exactly half.
The currencies of twenty nations experienced no change at all vs. the dollar. Our trade imbalance improved with sixteen of them.
There was no currency data available for eleven nations.
If we narrow our focus to our fifteen largest trading partners, who account for 95% of America’s trade volume, we find that ten of them experienced a decline in the value of their currency. Our balance of trade weakened with all of them but one – France. However, it should also be noted that, of these ten countries, eight of them are more densely populated than the U.S., and our trade imbalance worsened with every one of them. Of the remaining five nations, three experienced an increase in the value of their currency – China, Japan and India. Yet, our trade imbalanced worsened with all three, who also happen to be much more densely populated than the U.S.
Two of the fifteen had a stable currency valuation in 2012 – Saudia Arabia and Venezuela – both big oil exporters. Our balance of trade improved with both of them in 2012.
It’s difficult to separate the effect of currency valuation from the effect of population density on our trade imbalance in manufactured goods. But, while the effect of population density is clear – that trading with nations much more densely populated virtually assures a worsening trade imbalance – the effect of currency valuation is sketchy at best. Of the 132 nations who experienced a change in currency valuation in 2012, our trade imbalance responded as economists would predict in only 78 of those situations – 59% of the time.
2012 was a year in which the dollar rose relative to most currencies. And it was a year in which our trade imbalance worsened. Was it because we continue to pursue free trade with badly overpopulated nations or was it because of currency valuation? Maybe it would help to take a longer-term perspective. Stay tuned for the next post on this subject.