$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/