$US-JPY Exchange Rate vs U.S. Balance of Trade with Japan

July 29, 2010

Continuing the series of posts dedicated to exploring the effect of currency exchange rates on the U.S. balance of trade, we now turn our attention to Japan.  Of the countries we’ve examined so far – Australia, Brazil, Canada, China and Colombia – only China has broken the mold, exhibiting a tendency for their trade surplus to grow in spite of a falling dollar.  But China is also the only one of this group that is far more densely populated than the U.S.  Is it possible that the effect of exchange rate breaks down in the face of a far more dominant effect on trade – a big disparity in population density?  We need more data from the ranks of densely populated countries.  So now let’s take a look at Japan.  Here’s the chart:

$US-JPY Rate vs Balance of Trade

In this case, I went back to 1985 and also adjusted the trade data for inflation, expressing the balance of trade in 2005 dollars.  Unlike the less densely populated nations of Australia, Brazil and Canada, this chart exhibits the same tendency that we saw for China – that a falling dollar has had no effect on the balance of trade.   If anything, there is a slightly negative correlation between exchange rate and the balance of trade.  The only exception has been in the last three years, when our balance of trade with Japan improved markedly.  The deficit in manufactured goods shrank by 42%.  However, our total trade deficit with the whole world shrank by about that much in the same time frame, not because of dollar weakness but because of the global near-depression.

A second factor working to erode Japan’s trade surplus with the U.S. is the emergence of China in the global economy.  Beginning in the early part of this decade, the Chinese have been steadily muscling in on Japan’s export business.  This will be an interesting dynamic to watch in the coming years.  If Japanese exports to the U.S. and Europe continue to slide, their economy will be in a world of hurt.  The deficit spending required to keep their economy from sliding into deep recession will make Greece look like a penny-pincher.  And Japan already has a serious deficit and debt problem.

Here’s an update of the theory score sheet:

Theory Correlation Score

So far, exchange rate theory has failed the test when large population density disparities were involved.  But, with the exception of tiny Colombia, the population density disparity theory has accurately predicted whether or not the U.S. would have a trade surplus or deficit.  Still, we only have two data points with big population density disparities.  Next up:  Germany.


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

Effect of Exchange Rates on Trade with Brazil and Colombia

July 25, 2010

Continuing our series examining the relationship between currency exchange rates and balance of trade, we now take a look at trade between the U.S. and two South American countries:  Brazil and Colombia.  In 2009, Brazil was America’s 11th largest trading partner.  And, given Colombia’s small size, they’re no slouch either.  So how has the balance of trade between the U.S. and these two countries been affected by the exchange rate between the dollar, the Brazilian real and the Colombian peso?  Has a stronger dollar led to declining trade balances, or a falling dollar resulted in improved trade balances for the U.S., as economists would predict?

Here are the charts.

$US-BRL Rate vs Balance of Trade $US-COP Rate vs Balance of Trade

We’re starting to see a pattern here.  These charts are virtually identical, and both are virtually the same as the charts for Australia and Canada that we looked at earlier.  There’s a good correlation between exchange rate and trade balance.  When the dollar rises, our trade balance gets worse and when it falls, the trade balance improves.

So much for my claim that population density disparities is what drives trade imbalances and not exchange rates, right?  Not so fast.  Once again, although the value of the dollar vs. the real has affected the balance of trade with Brazil, the balance has consistently been in favor of the U.S., as the population density disparity theory would predict.

In the case of Colombia, a nation slightly more densely populated than the U.S., they’re an oil exporter, leaving them flush with American dollars to spend on American manufactured products.  (Not to mention their illicit drug trade dollars.)

What we need here is a method for keeping score, so I devised the following spreadsheet:

Theory Correlation Score

For each country we’ve examined so far, I went year-by-year to see if the balance of trade followed the exchange rate theory.  That is, did our balance of trade improve in those years in which the dollar fell from the previous year, and did it worsen in those years in which the dollar rose?  I then totaled the number of years in which the trade balance behaved as predicted by the exchange rate, and divided by the total number of years.  For example, in the case of Canada, the trade balance behaved as predicted in 12 years out of 19, a 64% correlation.  (See the notes below the spreadsheet explaining the methodology.)

As you can see, for each of the less densely populated nations we’ve examined so far – Australia, Canada, Brazil and Colombia (where the population density ratio is less than or close to 1.0), there has been either a positive or strongly positive correlation between the balance of trade with the U.S. and the rise and fall of the exchange rate.  But in the case of China, more than four times as densely populated as the U.S., there is a strongly negative correlation.  That is, the U.S. balance of trade worsens as the dollar weakens.

In every case except Colombia, America’s balance of trade has been exactly as predicted by the population density disparity theory.  In the case of Colombia, where their population density is nearly identical to that of the U.S., the population density disparity theory barely applies at all, since there is very little disparity.  Nevertheless, since the U.S. is slightly less densely populated than Colombia but enjoys a surplus of trade in manufactured goods, I’ve scored it as not correlating with my theory.

All in all, this has been pretty inconclusive so far.  But stay tuned.  Next up is Japan.


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

$US-$Can Exchange Rate vs Balance of Trade

July 8, 2010

Yesterday we looked at the dollar-yuan exchange rate and found no tendency for a declining dollar to positively impact the balance of trade between the U.S. and China.  But that’s just one piece of data.  Today we’ll examine the effect of exchange rate on trade between the U.S. and Canada.

In this case we have more data available.  The following chart includes the total balance of trade between the U.S. and Canada dating back to 1985, the balance of trade in manufactured goods dating back to 2001 (the data I compiled in researching my book), and the exchange rate dating back to 1990.  Here’s the chart:

$US-$Can Rate vs Balance of Trade

Some observations:

  1. First of all, it’s important to note that, since Canada is America’s largest supplier of imported oil and gas, our balance of trade with Canada is dominated by trade in those categories.  Oil is priced in U.S. dollars.  A falling dollar results in higher oil prices.  Thus, as the dollar declines, one would expect that our balance of trade in oil would worsen.  Economics says that as the price of an imported commodity rises, imports will decline as consumers switch to domestic suppliers.  But that doesn’t work for oil.  Domestic supplies are maxed out and, in fact, declining.  We have no choice but to continue to import at the same rate.
  2. From 1990 through 2002, as the dollar soared in value by 35%, our balance of trade with Canada worsened by 625%, a move in the direction that economists would predict, but the size of the move is beyond what one would expect.  Early in this time frame, NAFTA (the North American Free Trade Agreement) was implemented (on January 1, 1994).  You can see that our trade deficit (again, driven by oil imports) really took off at that point.  Thus, the worsening of our total trade deficit with Canada during that time frame had much more to do with the implementation of NAFTA than it did with the strengthening of the dollar.
  3. From 2003 through 2008, however, our overall balance of trade with Canada continued to worsen in spite of a dramatic decline in the dollar.  This is likely due to the rising price of oil, coupled with rising demand.
  4. Looking at the effect of the exchange rate on trade in manufactured goods from 2001 to 2009, we see what seems to be exactly the relationship that economists would predict – that the falling dollar resulted in an improvement in our balance of trade, improving from a slight deficit to a tidy surplus of over $40 billion in 2009.  But is this really caused by the falling dollar or was it driven by the disparity in population density between the U.S. and Canada?  The U.S. is ten times as densely populated as Canada.  My theory would predict that, upon implementation of free trade between two such countries, the more densely populated will end up with the trade surplus in manufactured products.  And that’s exactly what has happened here. 

So is America’s  rising surplus in manufactured goods due to the falling dollar or due to the population density disparity?  It’s impossible to say with certainty based on just this one data point.  Our experience with China indicates that the falling dollar has no effect.  Our experience with Canada is inconclusive.  My prediction is that, as we examine more exchange rates with other countries, it will become clear that the effect of exchange rates is dwarfed by the effect of population density disparities, if there is any exchange rate effect at all.  Stay tuned.


Exchange rate data provided by OANDA:  http://www.oanda.com/?srccont=breadcrumb


Dollar-Yuan Exchange Rate vs. Balance of Trade

July 7, 2010

I recently promised a new series of posts that will explore the relationship (or more accurately, the lack of a relationship) between currency exchange rates and balances of trade.  It’s my contention that there is no relationship of any significance; that trade imbalances are much more heavily influenced by disparities in population density between the two trading partners.  In proving that trade balances in manufactured goods are driven by population density disparities, it’s just as important to disprove the usual suspects – currency exchange rates and low wages. 

This is the first post in this series that addresses exchange rates.  We’ll take a look at the dollar-yuan exchange rate and whether or not any relationship is evident between the exchange rate and our balance of trade with China.  The sole focus of the Obama administration’s trade policy has been badgering the Chinese to stop its practice of “pegging” the yuan to the dollar, allowing it to float freely and be determined by market forces.  Congress has threatened to pass legislation branding China a currency manipulator, potentially opening the door (under World Trade Organization rules) to punitive tariffs.  Economists have all agreed – China’s currency is undervalued by as much as 40%, and they have blamed this for America’s enormous trade deficit with China.

So even I was surprised when I compiled the data.  The dollar has steadily fallen since 2004 by 17% vs. the yuan.  Granted, the decline has been slow and has been managed by China, but the impression created by the Obama administration that the yuan has remained pegged at a fixed value is simply wrong. 

So here’s a chart of the exchange rate vs. the balance of trade:

Dollar-Yuan Rate vs Balance of Trade

If economists are right when they say that a falling dollar will improve our balance of trade, then we should see the trade deficit with China improve as the dollar declines.  But that’s not what we see here.  Instead, the trade deficit with China has actually worsened dramatically as the decline in the dollar-yuan exchange rate has progressed, worsening in four of the last five years.  It improved only in 2009.

Regarding the 2009 improvement, one might say that it has simply taken time for the reduced value of the dollar to take hold – that the balance of trade can’t improve until manufacturing capacity is rebuilt in the U.S. – something that might indeed take several years.  Such an explanation might hold water except for one very important fact:  the U.S. trade deficit with the entire world declined by 46% in 2009, thanks to the recession and its corresponding impact on global trade.  But America’s trade deficit with China fell in 2009 by only 15%.  In other words, were it not for the recession, it’s likely that our trade deficit with China would have substantially worsened. 

Therefore, if there is any cause and effect at all between exchange rates and balances of trade, this chart seems to indicate that a falling dollar is probably the result of a rising trade deficit.  The change in exchange rate is caused by the deficit, instead of the opposite cause and effect. 

It seems clear from this chart that those who pin their hopes on a falling dollar to reverse our trade deficit with China are barking up the wrong tree. 

But this is just an 8-year track record with one currency.  In future posts we’ll examine more currencies over a longer period of time. 


Exchange rate data comes from the OANDA web site: