The Effect of Currency Valuation on Trade? None!

Whenever some senator or congressman wants to appear tough on trade – usually during a campaign for re-election – they call on the president label a country like China or Japan a “currency manipulator.”  They do this because under the rules of the World Trade Organization a country that’s guilty of manipulating its currency can have tariffs levied against it.  Of course, it never happens.

The reasoning is that a nation that takes actions designed to weaken its own currency gives them an unfair trade advantage, making its own domestically-produced products cheaper for its citizens and for foreign buyers while making imports more expensive.  It all sounds perfectly logical.  But is it really valid?

In my recent posts, we found that there is a very powerful relationship between population density and trade imbalances in manufactured products.  Free trade with nations much more densely populated than our own is almost assured to produce a trade deficit, while free trade with nations less densely populated usually results in a trade surplus.  So strong is this relationship that it seems to be the dominant driving force in determining the balance of trade.  However, that then calls into question just how much of a role currency valuations have, if any.

I have done an exhaustive study of the subject, plotting the change in currency valuations for 159 nations vs. the U.S. dollar against the change in America’s trade imbalance with those nations over a ten-year period ending in 2014.  What I have found is that there is absolutely no correlation between the two whatsoever.

If there were some correlation, what we should see is that a strengthening of a nation’s currency vs. the dollar should yield an improvement in our balance of trade with that nation, since our exports become more affordable to the people of that nation while their exports are more expensive for our citizens.

Here’s what actually happened.  During the ten-year period from 2005 to 2014, the currencies of 80 nations rose vs. the dollar.  The currencies of 67 nations fell vs. the dollar.  And the currencies of 12 nations remained unchanged against the dollar.  Of the 80 nations whose currencies rose vs. the dollar, our trade imbalance improved with 44 of them.  That shows that the currency valuation theory is valid?  Not so fast.  Of the 67 nations whose currencies weakened vs. the dollar, our trade imbalance worsened with only 16 of them.  Add these together and our trade imbalance changed as the currency theory would have predicted with only 60 of the 147 nations, or 41% of the time.  (With the twelve nations where their currencies were unchanged, our trade imbalance improved with ten of them.)

In fact, if we plot the data for these 159 nations on a scatter chart, here’s what we see:  Currency Valuation vs. Balance of Trade2.  On a scatter chart such as this, if there is a correlation between the two variables – change in currency valuation vs. change in trade imbalance – the data points would tend to fall along a line.  As you can see, they don’t – not at all.  When I had Excel calculated a trend line with a “determination coefficient,” the coefficient (“R-squared”) came out to 0.002.  A perfect correlation would yield a coefficient of 1.0 and the data points would fall into a perfectly straight line.  Here, the coefficient is about as close to zero as you can get, meaning no correlation whatsoever.

Let’s take a closer look at our ten largest trade partners in 2014 and see how their currencies and our trade imbalances have fared over the past ten years.  Check this table:  Currency Valuation vs. Balance of Trade.  These ten nations accounted for nearly 73% of all U.S. trade in manufactured goods in 2014.  Their currencies increased in value vs. the dollar for seven of them, and fell for the other three.  But of these ten, our balance of trade changed as currency valuation would predict in only four cases.

Look at China.  In spite of the yuan appreciating in value vs. the dollar by 33%, our trade imbalance actually worsened by 82%.  Look at France and Germany.  In spite of the Euro rising by 12%, our balance of trade with these two nations worsened by 56% and 97% respectively.  (By the way, the next time you hear someone say that America needs to improve its productivity in order to be more competitive, ask them to explain why it is that the U.S. has a large trade deficit with France, arguably the least productive nation in the developed world.)

For anyone who bothers to actually study the matter, the real world data on currency valuation and trade imbalances proves beyond a shadow of a doubt that there is absolutely no correlation between the two.  It’s disparities in population densities that drives trade imbalances and currency valuation has nothing to do with it.

Surprising Facts About 2011 U.S. Trade Data!

I haven’t posted much lately because I’ve been working hard on analyzing the 2011 trade data, which was released by the BEA (Bureau of Economic Analysis) in late February.  My focus, of course, is on manufactured products, since that’s where the jobs are.  Separating the trade in manufactured goods from total trade for each nation is no small undertaking, since nowhere does the BEA report on “manufactured products” as a separate category.  It has to be done nation-by-nation, combing through hundreds of product end-use codes for each.  I’m now ready to begin reporting on what I’ve found, beginning with some interesting, surprising facts.  (More posts will follow.)

For those of you new to this web site and the concepts presented here, my goal is to create an understanding of the forces that drive global trade imbalances, especially America’s very large trade deficit in manufactured products with the rest of the world.  Why manufactured goods?  There are two kinds of “goods”:  natural resources and the products into which those resources are transformed through manufacturing. 

The reason for trade imbalances in natural resources is no mystery.  Nations deficient in a particular natural resource, as is the case with the U.S. and oil, will experience a trade deficit in that resource.  Nations with a surplus of such resources will have a trade surplus.  It’s as simple as that.  But there are also very large imbalances in the trade of manufactured products that aren’t so easily explained.  Economists blame many factors including low wages, currency manipulation, trade barriers and lax labor and environmental standards.  Yet, in spite of decades of efforts to address these issues, imbalances have only grown worse. 

In Five Short Blasts, I presented an entirely new explanation for trade imbalances:  the role of population density.  And, since publication of that book, I’ve also presented on this blog data that debunks the role of the traditional scapegoats – low wages and currency exchange rates.  Now we have a fresh batch of data for 2011.  Let’s examine whether population density still holds up as an explanation and whether wages and exchange rates have played any role at all. 

First, some explanation of my methodology is in order.  In my research prior to publishing Five Short Blasts in 2007, I discovered that the inclusion of tiny island nations and city-states in the data tends to obscure the relationship between population density and trade imbalances.  Almost without exception, tiny island nations have unique economies that are totally dependent on tourism.  Because such nations use tourist dollars to purchase manufactured products, the U.S. has a surplus of trade in manufactured goods with virtually every one of them, regardless of their population density.  And the trade with all of these nations taken together is so minuscule that it has no measurable effect on America’s balance of trade.  For those reasons, those nations are omitted from the study. 

Also, tiny city-states are somewhat similar in that they tend to have economies skewed by their imbalance between urban and rural settings and their nearly total lack of resources.  For this reason, I have rolled the data for such city-states into the data of their much larger, surrounding (or neighboring) nations.  (These city-states are Andorra, Gibraltar, Hong Kong, Macao, San Marino, Vatican City, Liechtenstein, Luxembourg, Monaco and Singapore.)  What’s left is a total of 165 nations. 

With all of that background, let’s begin with some basic facts about America’s balance of trade in 2011:

• In 2011, the U.S. balance of trade worsened by almost $60 billion, with the trade deficit increasing to $560.0 billion – a 12% increase.  Of this increase in the trade deficit, $46.3 billion was due to an increase in the deficit in manufactured products. 
• The U.S. had a trade deficit of $423.4 billion in manufactured products in 2011, compared to $377 billion in 2010.
• It’s natural to expect, then, that our balance of trade worsened (trade deficits grew larger or surpluses grew smaller) with the majority of nations.  But that’s not what happened.  Of the 165 nations examined, our balance of trade in manufactured products worsened with only 76 nations (46%).  It actually improved with 88 nations (54%).  (South Sudan is new to the study and did not exist in 2010.) 

 

Evidence of The Role of Population Density in Trade Imbalances

Now, let’s break this down by population density – or, more precisely, by population density relative to that of the U.S. – to see if some relationship emerges.  Of these 165 nations, 111 are more densely populated than the U.S.; 54 are less densely populated.  If population density is not a factor in trade imbalances, then the number of nations with whom the U.S. experienced a worsening in its trade balance – 76 nations – should be distributed proportionately among these two groups – 51 nations among the more densely populated nations and 25 among the less densely populated nations.  But here’s what actually happened:

• Of the 76 nations with whom our balance of trade worsened, 62 were nations more densely populated than the U.S.; only 14 were among the less densely populated nations.
• Although only 33% of nations are less densely populated than the U.S., of the 88 nations with whom our balance of trade improved, 44% (39) were among that group. 
• Of the 54 nations less densely populated than the U.S., the balance of trade improved with 39. 

That data on the change in our trade imbalance from 2010 to 2011 seems to show a relationship with population density.  But that’s just the change in the imbalance.  What about the imbalances themselves?  Of the 165 nations included in the study, the U.S. had a trade deficit in manufactured products with only 51 of them.  Since 67% of these nations are more densely populated than the U.S., we should find 34 of these trade deficits among the more densely populated nations and 17 of them among the less densely populated ones.  But here’s what actually happened in 2011:

• Of the 111 nations that are more densely populated than the U.S., the U.S. had a trade deficit with 47.
• Of the 54 nations less densely populated than the U.S., the U.S. had a trade deficit in manufactured goods with only 4. 
• Of the 51 nations with whom the U.S. had a trade deficit in manufactured goods, 47 (or 92.2%) were with nations more densely populated than the U.S.  The four less densely populated nations with whom we had a trade deficit in manufactured goods were Estonia, Laos, Sweden and Finland.

That is powerful evidence of a a strong relationship between population density and trade imbalances in manufactured goods. 

 

What about Low Wages as a Cause for Trade Deficits?

Unfortunately, it’s not possible to evaluate the role of wages directly.  This would require knowing the unit labor costs for every product imported and exported, and doing a complicated calculation to determine the average unit labor costs for the sum total of imports and exports.  However, we do know the “purchasing power parity” (“PPP,” roughly the nation’s gross domestic product divided by its population) for each nation, and PPP gives us a pretty good way to compare relative wage rates of one nation vs. another. 

In terms of PPP, the U.S. is one of the wealthiest nations in the world and, therefore, its workers are among the best-paid.  With a PPP of $48,100, the U.S. ranks fifth among the 165 nations included in the study.  Only Qatar, the Falkland Islands, Norway and United Arab Emirates have higher PPP.  So 161 of the 165 nations included in the study have lower-paid workers than the U.S.  But, since we have a trade deficit with only 51 nations, this immediately casts doubt on the claim that low wages cause trade deficits.  If lower wages cause trade deficits, then we should be experiencing trade deficits with 161 nations – not a mere 51. 

OK, maybe much lower wages are required.  So let’s divide these nations around the median PPP of $8,000 – 82 nations above the median and 83 nations below.  Surely we will find our 51 trade deficits concentrated among the low PPP nations.  Right?  That’s the theory.  Now here’s the facts:

• Of the 82 nations above the median PPP, the U.S. had a trade deficit in manufactured goods with 32. 
• Of the 83 nations below the median, the U.S. had a trade deficit in manufactured goods with only 19. 

Not only does this data not support the claim that low wages cause trade deficits, it seems to be solid evidence that either exactly the opposite is true or, more likely, that the cause and effect are reversed.  It may be that a large trade deficit with a nation tends to boost wages in that nation by driving up the demand for labor to fill manufacturing jobs.  As an example, consider Germany and Japan – two relatively high wage nations.  When put in per capita terms (thus adjusting for the relative size of a nation), our trade deficit with each is far larger than our trade deficit with lower-wage China.  Why?  Because their high wages are the result of a prolonged, strong demand for manufacturing labor created by our demand for their exports.  Wages in China, much newer to the stage of world trade, are rising fast.  If something besides low wages is the cause of a trade deficit (like population density?), then it’s logical to expect that high wages in the surplus country will follow, as happened in Germany and Japan and as is happening now in China.

 

What about Currency Exchange Rates as a Cause of Trade Imbalances? 

Finally, let’s examine what role, if any, currency exchange rates play in driving trade imbalances.  Economists and political leaders have been blaming “currency manipulation” by China for their enormous trade surplus with the U.S.  By keeping the value of the Chinese yuan artificially low, they claim, China’s exports are cheaper while imports into China are more expensive to Chinese consumers.  On the surface, this argument seems to make sense.  But because it seems to make sense, perhaps too little effort has been made to validate that theory.  If that theory holds water, then an examination of changes in currency exchange rates for all 165 nations should find that our balance of trade has tended to improve with those nations whose currencies rose relative to the dollar, while worsening among those nations whose currencies declined.  Here’s what actually happened in 2011:

• Of the 165 nations studied, 99 had a stronger currency in 2011 than in 2010.  19 experienced no change in exchange rate with the dollar.  Only 46 had weaker currencies. 

That fact alone already casts doubt on the currency theory since, as noted earlier, our overall balance of trade worsened in 2011.  Since the currencies of 99 nations (60%) – including China – rose in 2011 while only 46 nations (28%) saw a decline in their currencies, the U.S. should have experienced an overall improvement in its balance of trade.  It did not.  More facts: 

• With the 99 nations who had stronger currencies, the U.S. experienced an improvement in the balance of trade in manufactured goods with 52 of them (52.5%). 
• With the 19 nations with unchanged currency exchange rates, the U.S. experienced an improvement in the balance of trade with 12 of them.
• With the 46 nations who had weaker currencies in 2011, the U.S. experienced an improvement in the balance of trade with 24 of them (52%). 

So an increase in a nation’s currency was just as likely to produce a worsening of our trade imbalance as an improvement, and vice versa.  In other words, there’s absolutely no relationship between currency valuation and trade imbalance evident here. 

I’ll be the first to admit that a one-year move in currency exchange rate may not be enough to change the momentum of trade imbalances.  However, I’ve previously conducted a similar study of the effect of 18-year changes in currency exchange rates and found exactly the same thing.  (See https://petemurphy.wordpress.com/2010/11/17/study-finds-no-relationship-between-currency-exchange-rate-and-trade-imbalance/.)

How can this be?  Perhaps looking at it from another angle will shed some light. 

• Of the 51 nations with whom the U.S. had a trade deficit in manufactured goods in 2011, 40 nations’ currencies rose in value.  Two were unchanged.  Only 9 experienced a decline in their currency.
• Of the 114 nations with whom the U.S. had a trade surpluse in manufactured goods in 2011, 37 experienced a decline in their currency. 

From this we can conclude that currencies rise relative to the dollar in response to trade surpluses with the U.S.  However, changing exchange rates have absolutely no effect in reversing trade imbalances.  Therefore, those who pin their hopes on a rising Chinese yuan to bring manufacturing jobs home from China are going to be sorely disappointed, just as they have been as the yuan has risen in value for years.  Our trade deficit with China has only grown worse, just as our trade deficit with Japan only grew worse as Japan’s yen rose by over 300% over the past three decades. 

Conclusion:

From the United States’ 2011 trade data we can conclude two things: 

• it’s population density that drives our trade imbalances.
• wages and currency exchange rates play absolutely no role in those imbalances. 

I’ll be presenting some even more fascinating facts from the 2011 trade data in upcoming posts.  Unfortunately, those posts will probably have to wait for a couple of weeks.  But stay tuned!  You won’t want to miss them.

Weaker Dollar No Solution to Joblessness

http://www.cnbc.com/id/40214520

As I was postig the results of my study of currency exchange rates and trade imbalances – a study which showed that changes in currency exchange rate have no effect on trade – the above-linked article titled “Weaker Dollar Seen as Unlikely to Cure Joblessness” appeared on CNBC. 

The article begins by re-stating the now disproven economic theory:

A weakening currency traditionally helps a country raise its exports and create more jobs for its workers.

The article then goes on to make the case that a falling dollar won’t have this predicted effect.  I can add one more reason – the theory is flawed and not supported by the data.  A weaker dollar will have no effect on the prices of imports, as exporting nations will simply cut costs and subsidize their industries to hold the line on price, assuring that they maintain their share of the U.S. market.

Rising prices for imports certainly would bring manufacturing jobs back to the U.S.  But there’s only one way to make sure they rise sufficiently, and that’s for the U.S. to set the prices.  In other words, the U.S. needs to apply tariffs.  Tariffs must be applied to manufactured products, and the size of the tariffs must be proportional to the population density of the country of origin.  This would result in big tariffs on all products from China, even bigger tariffs on products from Germany, Japan and South Korea, but would leave products from nations like Canada, Australia, Saudi Arabia, Brazil and a host of others completely free of tariffs. 

The only problem we’d have then would be building factories fast enough to keep pace with demand.

Study Finds No Relationship Between Currency Exchange Rate and Trade Imbalance

Economic theory tells us that a falling dollar helps American exports by making them cheaper for foreign buyers and slows imports by making them more expensive.  Thus, a falling dollar helps domestic manufacturing and improves our balance of trade A stronger dollar has the opposite effect.  It seems to make sense, but the theory isn’t supported by the facts.

My study of the currency exchange rates between the U.S. and its fifteen largest trade partners (and one other) has found no relationship between exchange rates and the balance of trade.  I studied the total balance of trade for these nations for the period from 1990 through 2008, and the balance of trade in manufactured products from 2001 through 2008 against the rise and fall in exchange rates for the currencies of each nation in question.  (Data for manufactured products not available for years prior to 2001.) 

The study finds that, for total trade, there is absolutely no relationship between exchange rate and balance of trade.  The U.S. balance of trade was just as likely (or slightly more likely) to worsen in response to a weaker dollar as it was to improve, and vice versa.  A year-by-year analysis shows that the balance of trade responded to exchange rate changes as economic theory would predict almost exactly (but slightly less) than half of the time.  When the 19-year period is taken as a whole and compared to the change in exchange rate for each country, the balance of trade behaved as economic theory would predict in less than half of the cases.  And it seemed to make no difference whether the trade partner was more or less densely populated than the U.S.

If we narrow our scope to manufactured products only, the story is exactly the same except that if Singapore (the tiniest of America’s 15 largest trade partners) is removed from the data set, then population density does seem to matter.  For trade between the U.S. and nations less densely populated, the balance of trade does seem to respond to changes in currency exchange rates as economic theory would predict.  But that tendency decays with rising population density and, for trade with nations more densely populated than the U.S. by a factor of two, a weakening dollar has no effect on improving the balance of trade.  If anything, in trade with densely populated nations, the balance of trade tends to worsen regardless of a weakening dollar.

The population density of the trade partner is a far better predictor of the balance of trade in manufactured products.  (The population density theory applies only to manufactured products and not trade in natural resources.)  For trade partners less densely populated than the U.S., the theory correctly predicts a surplus of trade in every case.  For those nations more densely populated, the theory correctly predicted a trade deficit in 9 out of 11 cases.  (Since the theory doesn’t apply to tiny city-states, Singapore is excluded from the data set.) 

Here’s a summary of the study’s findings:

Theory Correlation Score

Conclusisons and comments regarding total trade:

1. Among the trade partners less densely populated than the U.S., the balance of trade responded to changes in currency exchange rate as predicted by economic theory, year-by-year, only 47% of the time.  Taking the 19-year period as a whole, the balance of trade responded as predicted by economic theory for only two out of five nations – 40% of the time.
2. Among the trade partners more densely populated than the U.S., the balance of trade responded to changes in currency exchange rate as predicted by economic theory, year-by-year, only 46% of the time.  Taking the 19-year period as a whole, the balance of trade responded as predicted by economic theory for only five out of twelve nations – only 42% of the time.
3. This lack of correlation between total balance of trade and currency exchange rate may be partly explained by the fact that, aside from manufactured products, the remainder of total trade is dominated by oil.  Since oil is priced in dollars, there is no exchange rate involved in the trade of oil. 

Conclusions and comments regarding trade in manufactured products:

1. Among the trade partners less densely populated than the U.S., the balance of trade in manufactured products responded to changes in currency exchange rate as predicted by economic theory, year-by-year, 49% of the time.  Taking the 19-year period as a whole, the balance of trade responded as predicted by economic theory for three out of five nations – 60% of the time.  Thus, there’s at least some slight indication that currency exchange rate does play a role in trade in manufactured goods with less densely populated nations.
2. Among the trade partners more densely populated than the U.S., the balance of trade in manufactured products responded to changes in currency exchange rate as predicted by economic theory, year-by-year, only 48% of the time.  Taking the 19-year period as a whole, the balance of trade responded as predicted by economic theory for six out of twelve nations – 50% of the time.  Thus, for densely populated trade partners, currency exchange rate plays no role in determining the balance of trade.
3. On the other hand, population density plays a powerful role.  In every case in the study, the U.S. enjoys a surplus of trade in manufactured products with less densely populated nations.  Conversely, the U.S. has a surplus of trade with only three out of twelve more densely populated nations.  One of these three, Colombia is only very slightly more densely populated than the U.S.  Both of the remaining two share a common trait – they are tiny nations that serve as a port of entry for the larger surrounding countries. 

In conclusion, other than some slight indication of a correlation for trade in manufactured products with less densely populated nations, currency exchange rate has absolutely no effect upon balance of trade, especially with densely populated nations. 

Clearly, those who are pinning their hopes on a weaker dollar to rebalance the global economy, especially trade with China, are barking up the wrong tree.

$US-TWD Exchange Rate vs. U.S. Balance of Trade with Taiwan

Continuing my series of examining the effect of exchange rate (or lack thereof) on trade imbalances, I’ll now examine Taiwan, America’s 9th 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.

Taiwan is a nation almost twenty times as densely populated as the U.S.  Therefore, my theory of the effect of population density on per capita consumption predicts that we’d have a trade deficit with Taiwan.  We do, and it’s a whopper.  When expressed in per capita terms, our trade deficit in manufactured goods with Taiwan is four times worse than our deficit with China. 

But how has the deficit responded to changes in the currency exchange rate?  Here’s a chart of the data:

$US-TWD Rate vs Balance of Trade

As you can see, in the 16 years covered by this data, the U.S. trade deficit responded to changes in the currency exchange rate as predicted by economists (improving with a falling dollar and vice versa) only 7 times, or 44% of the time.  In other words, the trade deficit in this case was more likely to do just the opposite of what economists predict.  And, when this 16-year period is taken as a whole, we see that in spite of the dollar strengthening over that period, the balance of trade with Taiwan actually improved instead of worsening, exactly the opposite of what one would expect.

So here’s an update of the theory correlation chart with Taiwan included:

Theory Correlation Score

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 12 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. 

There are still five nations to go to round out this study of America’s top 15 trading partners and the effect of currency valuation on balance of trade:  The Netherlands, India, Singapore, Venezuela and Saudi Arabia.  In the interest of wrapping up this study, I’ll include all five in the next installment. 

*****

Exchange rate data provided by www.oanda.com.

$US-FRF/Euro Exchange Rate vs. U.S. Balance of Trade with France

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. 

$US-FRF&Euro Rate vs Balance of Trade

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:

Theory Correlation Score

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.

$US-KRW Exchange Rate vs U.S. Balance of Trade with S. Korea

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:

$US-KRW Rate vs Balance of Trade

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:

Theory Correlation Score

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.

 

$US-GBP Exchange Rate vs Balance of Trade with the U.K.

Continuing the series in which I am researching the validity of the economists’ claim that a weaker dollar improves our trade balance, we now turn our attention to the United Kingdom and the dollar-British pound (GBP) exchange rate.  So far we’ve seen that, although a weakening dollar does improve our balance of trade when dealing with less densely populated nations, we’ve seen that there is no effect at all with much more densely populated ones.  In fact, if anything, a falling dollar seems to have the opposite effect.  Trade balances worsen. 

But, so far, we’ve only examined a relatively few nations.  So now let’s turn our attention to trade with the U.K.   The U.K. is nearly 7-1/2 times as densely populated as the U.S.  So my theory would predict that changes in exchange rate would have no effect on our balance of trade with them, since the influence of the disparity in population density  would dwarf any effect of changes in exchange rate. 

For some reason, I had a gut feeling that this one was going to fly in the face of my theory.  But that gut feel was wrong.  Here’s the chart:

$US-GBP Rate vs Balance of Trade

As you can see, there is no correlation between exchange rate and the balance of trade with the U.K. whatsoever.  In fact, there seems to a “weak negative correlation,” since changes in exchange rate were more likely to yield the opposite effect upon trade imbalances than what economists would predict (if there is any cause and effect at all).  The correlation score landed almost right on the trend line and strengthened the correlation between population density and the logarithmic decline in the effect of exchange rate.  Here’s the correlation chart, with the U.K. now included:

Theory Correlation Score

It’s hard to overstate the significance of this study.  I’m not aware of any other study that has attempted to quantify the effect of exchange rates on trade imbalances and how that effect may be influenced by disparities in population density.  It’s becoming quite clear that currency exchange rates are powerless to prevent a trade deficit in manufactured goods with a nation that is much more densely populated (by more than a factor of two). 

I’ll continue this series until all of America’s top fifteen trade partners have been included.  Next on the agenda:  South Korea.

*****

Currency exchange rate data provided by www.oanda.com.

$US-MXN Exchange Rate vs. U.S. Balance of Trade with Mexico

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.

$US-MXN Rate vs Balance of Trade

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:

Theory Correlation Score

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/

$US-DEM/EUR Exchange Rate vs U.S. Balance of Trade with Germany

Continuing our series of examining the effect of exchange rate on the balance of trade between the U.S. and its major trading partners, we now turn our attention to Germany.  Previously, we have seen that the effect of changes in the exchange rate on the balance of trade has been as economists would predict when the U.S. is dealing with countries roughly equal in population density or less densely populated – countries like Australia, Canada, Brazil and Colombia.  When the dollar falls, our balance of trade improves, and vice versa.  However, the predicted effect seems to break down when dealing with nations far more densely populated – nations like Japan and China.  Changes in the currency exchange rate seem to have no effect whatsoever or, if anything, yield the opposite effect.  That is, a decline in the dollar is more likely to result in a worsening of America’s balance of trade.  Or more likely, a worsening trade deficit yields a decline in the dollar, as economists would predict, but that decline is powerless to offset the effects of population density disparity and reverse the deficit, contrary to what economists would predict.

So let’s see what happens in America’s trade with Germany, another nation far more densely populated than the U.S., by a factor of 7.  Here’s a chart of the U.S. balance of trade with Germany vs. the exchange rate between the dollar and the Deutschmark (prior to 1998) and the dollar and Euro (following the adoption of the Euro in 1998). 

$US-DEM&EUR Rate vs Balance of Trade

In the case of Germany, there is no correlation, positive or negative, whatsoever.  Exactly 50% of the time, the balance of trade responded as predicted by economists in response to changes in the exchange rate.  But the other 50% of the time, changes in the exchange rate yielded the opposite result.  And look at the changes over the full period of time for each currency.  From 1990 to 1997, a small 7% rise in the dollar (from 1.61 DEMs to 1.73 DEMS) resulted in a 62% worse trade deficit – much worse than the small rise in the dollar would predict.  But from 1998 through 2009, a 21% decline in the dollar from .92 EURs to .727 EURs yielded only a 7.6% improvement in the trade deficit.  By far, most of that decline in the deficit was due to the global economic crisis that took hold in late 2008.  If we take away 2009 trade results, a 21% decline in the dollar actually resulted in a 40% worse trade deficit with Germany.  Were it not for the global economic crisis in 2009, we would conclude that the effect of a falling dollar is actually contrary to what economists predict. 

Here’s an update of the correlation tracking mechanism, with these results for Germany now included:

Theory Correlation Score

As you can see, a trend is taking shape.  When dealing with countries of similar population density, the correlation score tends to be greater than .5, indicating that changes in exchange rate produce the changes in trade balance that ecnomists predict.  But, when the trading partner is more densely populated (and the break seems to occur at about 2.0, when nations are at least twice as densely populated as the U.S.), the effect breaks down, and a weakening dollar has virtually no effect on reversing trade deficits. 

On the other hand, my theory of the effect of population density on per capita consumption and on trade imbalances has accurately predicted in all but one case so far (trade between the U.S. and Colombia) whether the trade imbalance would be a surplus or deficit. 

Next up:  Mexico.

*****

Exchange rate data provided by http://www.oanda.com/