Currency Valuations and Trade, 2001-2012

Economists claim that, when the dollar strengthens vs. other currencies, our trade deficit will worsen as our exports become more expensive for other nations and as our dollar goes further toward the purchase of imports.  Our large trade deficit with China is often blamed on the Chinese manipulating their currency to keep it artificially low in value in order to protect their trade surplus with the U.S.

In my previous post, in which we examined the effects of changes in curency valuation from 2011 to 2012 – just one year’s worth of data – we concluded that any such evidence in support of economists predictions was pretty sketchy at best.  We concluded that tracking the data over a longer time frame was necessary.

So, in this post, we’ll examine changes in currency valuations and America’s imbalances in trade in manufactured goods from 2001 to 2012.  Surely, this should be enough time for long-term changes in valuations to have their effect on trade imbalances if, indeed, there is any effect at all.

Here’s a scatter chart that plots the change in currency valuation vs. the change in America’s trade imbalance in manufactured goods over this twelve-year time frame:  2001-2012 Change.  One thing jumps out right away – that most of the data points lie to the left of the y-axis, indicating that most nations’ currencies fell in value relative to the dollar.  This would seem to suggest that America’s trade imbalance should have worsened over this time frame.

It depends on how you look at it.  In fact, America’s trade imbalance actually worsened dramatically during that time frame.  But if you simply average the change for each country, without weighting them for our trade volume (in other words, for example, tiny Cameroon is counted the same as China) the average change in America’s trade imbalance is a big improvement of 286%, in spite of an average decrease in exchange rate (or strengthening of the dollar) of 11.1%.  You have to look at the individual data points to understand this large discrepancy.

There were many very large swings in our trade imbalances over this 12-year time frame.  For example, we experienced a worsening imbalance of more than 1000% with three nations:  Estonia (-7,732%), Nicaragua (-1,388%) and Vietnam (-1,000%).  On the other hand, we experienced an improvement in our balance of trade of more than 1,000% with 15 nations.  They are Malawi (4,827%), Iraq (4,815%), Iran (3,770%), Ethiopia (3,416%), Sudan (2,624%), Guinea-Bissau (2,033%), Benin (1,48%), Papua New Guinea (1,868%),  Suriname (1,856%), North Korea (1,732%), Mozambique (1,597%), Russia (1,345%), Tajikistan (1,231%), United Arab Emirates (1,170%) and Togo (1,101%).

The U.S. experienced an improvement in its trade balance in manufactured goods of between 500% and 1,000% with fifteen other nations, but let’s stop right here.  An examination of the above list of 15 nations makes it apparent that there is much more at play here than population density or currency valuations to explain such huge increases.  There’s politics at play.  You’ll notice many African nations on this list.  It’s no secret that, as China’s influence in Africa has grown as Africa has become a major source of resources and raw materials for China’s economic expansion, the U.S. has tried to counter China’s growing influence there with big increases in foreign aid.  And all aid is counted as exports at book value.  Iraq and Tajikistan?  Huge influxes of military equipment and supplies to prosecute the wars in Iraq and Afghanistan.  Iran (until recently) an attempt to curry favor with the more moderate regime that has taken hold there.

So averaging all these countries together is yielding a very distorted picture.  As we did in my previous post, let’s simply break it down by country – which ones’ currencies increased or decreased in value, and how did our trade imbalance with them respond?  Of the 164 nations studied, 67 experience a weakening of their currency.  Our trade imbalance weakened with 21 of them.  (Economists would predict that our trade imbalance would have worsened with a majority of them, not by only 31%.)

The currencies of 76 nations rose in value.  Of these, our trade imbalance improved with 52 of them.  This is more in line with what economists would predict.  In seven cases, currency valuations were unchanged.  Our balance of trade weakened with one of them.  (There was no currency data available for 14 nations.)  So, all total, our trade imbalance responded as predicted in 73 of 156 cases – a little less than half.  What this tells us is that changes in our trade imbalance as a result of currency valuation changes was completely random.  There is no relationship whatsoever.

And what if we focus on just America’s top 15 trade partners who account for 95% of all of America’s trade?  What we find is that the currencies of eleven of them rose from 2001-2012 relative to the dollar.  In response, our balance of trade improved with only three of them – Canada, Brazil and the Netherlands.  Three others experienced weakening currencies – Mexico, India and Venezuela.  Our balance of trade worsened with all but Venezuela.  Saudi Arabia’s currency was flat (since it’s tied to the dollar).  Our balance of trade improved with them.  So, when it comes to our top trade partners, our balance of trade responded over a 12-year period as economists would suggest  in only four cases – exactly the opposite of what economists would predict.

Conclusion:

This results of this twelve-year study prove that there is absolutely no merit to economists’ claims that currency valuations plays a  role  in driving trade imbalances.  Blaming other nations for manipulating currency valuations to gain unfair trade advantages is a complete waste of time.

Another of economists’ popular scapegoats for trade imbalances is the lure of low wages in foreign countries.  We’ll explore the validity of this claim in an upcoming post.

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