from Follow the Money

The FX market doesn’t think the US should adjust … at least not right now.

October 11, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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The dollar has been rather strong relative to the yen for some time now.  And it is currently getting even stronger

The dollar was weak against the euro at 1.28 – and at say 1.25, it is still pretty weak.  Ask Airbus, which sells planes for dollars and buys parts in euros.  But right now the dollar is also rallying against the euro.

And my friends at Danske “Geyser Crisis” Bank think the dollar could reach 1.16 or so.  Ok, 1.16 is just their headline -- but they are looking for 1.20.   Danske doesn’t think that the US is the Iceland of the G-3.

If the dollar continues to rally against the other major currencies even as the US economy slumps, well, that will have consequences.  

For one, don’t look to exports to help the US get out of a slump.  And don’t look for the US slump to bring about a big improvement in the US balance of payments. 

Getting a big improvement in the current account deficit is hard, given that the US imports a lot more than it exports and net interest payments are set to rise sharply. So, setting a big swing in oil prices aside, the scenario where the US trade deficit falls is one where US import growth slows and US export growth stays strong.   Not one where both import and export growth slows.

And for that matter, if China's exports continue to grow at a 30% y/y pace -- faster than they were growing earlier this year -- it isn't obvious to me that US import growth is slowing.  At least not yet.  Asian electronics exports seem to be picking up, and presumably not all those exports are going to Europe.

Supporting charts and historical data are below the fold.A US slump – even if the slump fell short of an outright recession – would slow US import growth.  But if the market in its wisdom concludes that it should bid up the dollar as the US slows, US export growth also will likely slow.    Particularly if global growth slows a bit. That makes external adjustment a bit harder.   

The following graph shows --  I think – that the broad dollar does have an impact on US export growth, with a lag of about two years.  From 1990 to 1996 the dollar -- I used the Fed's broad dollar index -- was rather weak.  The result:  Exports increased as a share of GDP, and broadly speaking kept pace with imports.   From 1995 to 2002, the dollar gained in strength.    And guess what, exports fell as a share of US GDP.   The tech boom of 2000 induced a surge in US tech imports and exports (as well as a surge in oil prices), so export blipped up in 2000.  But the overall trend is down.   

The dollar’s 2002-04 slump had the expected impact as well.  Exports are now rising as a share of GDP.     If the dollar rallies, well, export growth will likely slow.


If you look at trends in US trade over a longer period, it is striking to me that US exports are not really much higher as a share of US GDP than they were in 1980.    And there seems to be a difference between the widening of the trade deficit in the early 1980s and the widening now.   The fall in the deficit in 80s largely came because  exports fell as a share of US GDP (blame the strong dollar).  Imports were broadly stable.  The collapse of oil prices clearly helped – no doubt oil imports were falling while non-oil imports were rising.   But there also was clearly a lot of capacity in the US export sector ready to respond to dollar depreciation. 

What is different now – apart from the fact that the deficit is a lot bigger?   The rise in the deficit comes overwhelming from a rise in imports – not a fall in exports.   After the boom of the last three years, exports are now about as large a share of US GDP as they ever have been. 

That raises a question in my mind: Is the US currently making the investments needed to bring goods and services exports up to 15% of GDP?   My gut answer is no.  

If not, the only real way the trade deficit can close quickly is if imports fall back as a share of US GDP.   And that, unfortauntely, will take more than oil at $55-60.   

 Bob Rubin has good reason to be worried.   But apparently, on this, Rubin and Greenspan don’t see eye to eye.

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