The Falling Dollar and the Stubborn Trade Deficit

Since October 2006, the euro has risen about 13 percent against the dollar but don’t expect dramatic improvements in the U.S. trade deficit until China and other Asian exporters permit their currencies to rise significantly too.

Large U.S. trade deficits and excessive foreign borrowing are driving down the dollar against the euro, the British pound and several other currencies. American and European businesses compete intensely in global markets, and a cheaper dollar advantages U.S. exporters.

Since October 2006, U.S. monthly exports have jumped $14 billion. Yet, the U.S. trade deficit, though fluctuating month to month, remains about $58 billion, because oil prices are rising, and the Peoples Bank of China and other Asian central banks have stepped up purchases of dollars and other foreign securities to keep their currencies cheap.

Oil, Chinese consumer goods, and automobiles account for about 98 percent of the U.S, trade deficit.

Net imports of petroleum are about $24 billion, up from $5.5 billion in December 2001. Retuning conventional gasoline engines, hybrids, nuclear power, and alternative energy sources could substantially reduce oil consumption. These solutions require national leadership, but both Republican and Democratic Party leaders have failed to champion comprehensive policies to accomplish what is possible.

Meanwhile, a falling dollar drives up the oil import bill, because petroleum is priced in dollars and a cheaper dollar permits foreign consumers, who earn their incomes in other currencies, to aggressively bid up the price. No surprise, oil seems headed for $100 a barrel.

The bilateral trade deficit with China is about $23 billion, up from $5.5 billion in December 2001, in large measure because China keeps the yuan cheap. That makes Chinese products in U.S. stores artificially inexpensive, and U.S. exports to China too costly.

China revalued the yuan from 8.28 to 8.11 in July 2005, and has since permitted the yuan to rise 3.4 percent every twelve months. Modernization raises the true underlying value of the yuan more than 5 percent a year, and it remains 40 to 50 percent undervalued.

Automotive products contribute $10.1 billion to the monthly deficit. Mexico and Canada account for $3.6 billion, reflecting the cross-border supply chains of the Detroit automakers. Those production decisions change only slowly. For example, GM has announced its exports will not be much altered by the decline in the dollar.

German automakers account for $1.7 billion of the trade deficit, but U.S. imports of their products are mostly higher-priced models within their vehicle classes. Total sales will not greatly respond to price changes driven by exchange rate movements.

Korean and Japanese automotive products account for $4.7 billion of the deficit, and a large share face fierce price competition. Having successful assembly facilities in the United States, Asian manufacturers could move more production here, but the won has risen only about 4 percent against the dollar, and the yen has gained much less.

The central banks of Japan and Korea have aggressively stepped up sales of yen and won for U.S. dollars and other securities to keep their currencies cheap against the dollar. This discourages Toyota, Hyundai and others from moving more auto assembly and sourcing to the United States.

The International Monetary Fund publishes Central Bank holdings of dollars and other securities, providing an accurate picture of currency market intervention. China and several other countries have increased intervention to keep their currencies cheap against the dollar. This forces the U.S. dollar lower against the euro, British pound and Canadian dollar, which generally float without central bank intervention.
Annual Currency Market Intervention
(Billions, U.S. Dollars)

2005 2006 2007*
China 207.0 247.0 489.5
Japan 0.4 45.4 63.5
Korea 11.3 28.6 24.5
India 6.3 38.8 92.9
Brazil 0.8 32.0 102.8
Russia 55.1 119.7 159.6
*estimated through September (latest data)

In 2007, these central banks’ purchases of predominantly U.S. dollar-denominated securities will exceed $900 billion and the U.S. trade deficit.

It is fashionable to tag the U.S. federal budget deficit for these purchases, but this deficit is on track to be only $200 billion in 2007. Currency manipulation is not about funding U.S. federal spending, it is about boosting exports to the United States.

The fall in the dollar against the euro gave U.S. exports a boost, showing exchange adjustments can have their intended effects on the trade deficit. However, until the United States does something about its appetite for oil and China and other mercantilist states stop manipulating their currencies, the United States will continue to have large trade deficits.

PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.


PETER MORICI is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.