from Follow the Money

Are there signs dollar depreciation is (finally) having a big impact on trade flows?

April 1, 2005

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I suspect so.

Unfortunately, for the US, right now dollar depreciation seems to be doing more to help China’s trade balance than to help the US trade balance.

The US trade deficit is still growing, even if you leave oil out. Non-oil import growth exceeds export growth.

Not so in China. Export growth there now far exceeds import growth. Apparently, China’s exports to the EU are growing particularly rapidly. And with the renminbi’s depreciation against many currencies, imports are now more expensive. That, along with large increases in China’s own capacity to produce steel and many basic chemicals, seems to be slowing the pace of China’s import growth. China’s trade surplus looks likely to balloon in 2005, even in the face of an adverse oil shock.

The change in the dollar/ euro (and the dollar’s value against a range of other currencies) is helping the US out though, just in a different way. It likely increased the value of US assets abroad substantially during the course of 2004. The Fed estimates valuation gains may have offset $400-450 billion of the $665 billion current account deficit. If US net debt only rose by $250 billion, to about $2.9 trillion, the US external debt to GDP ratio probably stated roughly constant at around 25% of GDP in 2004 -- despite a current account deficit of over 5% of GDP.

I have not found a data series that provides a country by country breakdown of US external investment at market value (the BEA data that I have found for FDI values the FDI at current cost).

But, after leaving out bank claims, US assets abroad clearly denominated in dollars and claims on the Caribbean (offshore US companies, so in dollars) and making a bunch of adjustments to estimate the currency composition of US direct investment at market value I came up with an estimate for US assets abroad denominated in foreign currency of around $4.5 trillion at the end of 2003. 70% of those assets are in Europe, Canada and Australia -- and another 10% are in Japan. My back of envelope estimate of valuation gains from currency moves was around $325 billion, not far from the Federal Reserves’ estimate.

The fall in the dollar/ euro to $1.36 at the end of the year did did WONDERS for the US net international position.

Note: My estimate was based only on currency moves, and ballpark estimates of the currency moves -- 8% adjustment v. Europe and Canada, 4% v, Japan, 5% v. everyone else. I made no attempt to capture any difference between equity market returns abroad

My bottom line on valuation effects. Most US assets are in Europe and Canada, not Asia. No doubt, the big move in the euro/ dollar has kept the US debt to GDP ratio from exploding over the past few years.

But don’t expect this to continue. The dollar is unlikely to depreciate another 40% plus against the euro. The prospective valuation gains from the mostly likely next stage of dollar adjustment (v. Asia and emerging economies more generally) are comparatively small.

The rise in the euro has -- to date -- translated into much higher valuations of US assets in Europe, very limited increases in import prices, even from Europe (the Fed Chairman thinks more price hikes are on the way ... but so far there is little evidence that the US has entered into the J curve phase of the trade adjustment), trivial rises in the interest rate the US has to pay on its net debt -- and no improvement in the trade balance.

A major adjustment against Asia would likely have a rather different feel.

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