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

September 1, 2010

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.