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:

Geithner: China Currency Manipulation a “Significant Issue”

January 21, 2009

As reported in this linked article, Timothy Geithner, Obama’s Treasury Secretary nominee, when questioned about currency manipulation by China, described it as a “significant issue” and as “… an important issue for the country …” 

I’ve really got my antennae up, alert for any clues as to whether or not Obama will really take meaningful action to restore a balance of trade.  This is just one, small, early indication that he’s willing to take it on.  Yes, I’m making a bit of a leap from Chinese currency manipulation to our overall trade deficit, but why else would Obama be concerned about this issue?  Does he merely want American consumers to pay more for imports from China?  It doesn’t seem logical that that’s all he’s after.  A strengthening yuan would indeed drive up the cost of Chinese imports, but what he’s really after is a restoration of the profit potential to motivate a return to manufacturing products domestically, driving up the demand for labor which, in turn, would drive up incomes, more than off-setting any rise in prices. 

Of course, if we wait for currency valuation to improve the trade deficit, we’ll be waiting forever, just as we have for the last three decades.  The dollar may fall against the yuan, but the Chinese will simply compensate in some other way – perhaps by increasing the government’s subsidies of Chinese manufacturers – in order to hold prices down.  So the real question is how quickly Obama will run out of patience.  When he does, it’s going to be fun to watch what happens!

Crackdown on China Trade Tactics: Will It Help?

December 24, 2008

Obama has promised to get tough on trade, cracking down on a wide range of practices ranging from subsidies to currency manipulation.  The linked article chronicles the challenges.  But will any of this really help reduce our trade deficit and bring manufacturing jobs back home, or will it initiate a global game of “whack-a-mole” where new trade offenders pop up as quickly as others are dispatched?

If the Obama administration attacks Chinese government subsidies, new trade barriers will pop up by the time the WTO has ruled against the old ones.  And by the time anti-dumping cases meander their way through the WTO bureaucracy, currency manipulation will have rendered the cases moot by restoring the profitability of the exports.  So then the focus turns to currency manipulation:

U.S. labor and trade groups will also browbeat the incoming administration to brand China a currency manipulator, potentially opening the door for other steps to pressure Beijing, including a possible complaint to the WTO.

China’s exchange rate with the United States is a festering complaint of many U.S. manufacturers who say Beijing deliberately undervalues its currency to boost exports.

“We are very committed to seeing some strong action on China’s currency,” said Thea Lee of the AFL-CIO labor group.

Obama, who said that China’s yawning trade surplus with the U.S. was “directly related to its manipulation of its currency value,” had backed legislation that would designate currency manipulation as a subsidy under U.S. trade remedy laws, noted Gil Kaplan, chairman of the Committee to Support U.S. Trade Laws.

“That was important legislation and I hope Obama will push forward some kind of legislative solution on currency manipulation,” said Kaplan.

Branding China a “currency manipulator” opens the door to imposing tariffs on China.  While that sounds promising, it’s unlikely to have much effect on our overall trade deficit.  Manufacturers will simply flee China and head for someplace else where gross overpopulation has produced a bloated labor force – places like India and Bangladesh.  The trade deficit with China will surely decrease, but other deficits will grow as quickly.  And, by the way, why single out China?  Japan has been at it much longer and makes China look like a rank amateur when it comes to currency manipulation. 

Such a piece-meal approach to trade is ultimately doomed to failure because it tinkers with symptoms while ignoring the root cause – the huge disparity in population density between the U.S. and so many of our trading partners.  Without a global system of tariffs designed to address huge imbalances in the supply and demand of labor, the overall trade deficit will persist.  The focus needs to be on our overall trade deficit, not on one country or another.  When expressed in per capita terms, our deficit with China is no worse than that with many other densely populated countries.  It’s time to stop blaming the trade policies of other nations and turn the focus on ourselves.  Our own trade policies are the problem.  We need a policy that assures a balance of trade regardless of what other nations do.  Our trade deficit is our responsibility, not theirs. 

Before closing, there’s one statement in the article that merits comment:

Obama’s trade dispute task-list is likely to grow, as labor and industry groups push agendas that will place him on a delicate tight-rope — to be seen to be protecting U.S. jobs while avoiding a potentially disastrous trade war with Beijing.

First of all, it’s time to stop being “seen to be protecting U.S. jobs” and actually begin doing it.  Secondly, we’re already in a “disastrous trade war with Beijing” and we’re losing badly because we haven’t had the guts or common sense to even put up a fight.  If and when we do decide to engage, it’s impossible to lose the war when you’re the one who has the trade deficit.  It’s no different than if FDR responded to the attack on Pearl Harbor by saying, “let’s not fight back – that might really piss them off.”