- Blog Post
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As readers of this blog no doubt know, the dollar rallied v. the euro last week.
Not that most of America noticed. In much of America’s heartland, the dollar’s value does not make the financial news, let alone the front page -- but it does creep into the travel section. The value of the dollar, for most Americans, is defined by the cost of a European vacation! That is the one thing people buy in euros, or pounds.
Far fewer Americans take vacations in Taiwan, Malaysia or Guangzhou.
But a mental map based on the tourist dollar simply may not produce the right mental map for the current world economy. Using 2004 trade data, China and Mexico combined should have a larger weight in the trade-weighted dolar than the euro, the pound, the Swiss franc and all other small European currencies combined. Yet changes in the peso-dollar and renminbi-dollar don’t get anywhere near the inkspace devoted to changes in the euro-dollar.
The European vacation analogy can be extended further. While the price of a European vacation has increased, higher prices have not stopped Americans from spending a week or two in the old world. US tourists are heading to Europe at the fastest pace since 2000 -- i.e. before September 11 and the recession. Americans bought more European vacations in 2004, and, judging from the import data, more of most everything else as well. The falling dollar has helped US "tourism" exports though: Europeans are heading to the US to ski, to shop, or just to get a bit of sun in Florida. See Amy Yee’s article in the 12/30 FT (subscription required).
Growing US spending on European vacations is consistent with the Neiman-Marcus economy: well-to-do Americans have kept on spending this year, whether on luxury cares (sales increased four times the pace of the broader market), luxury goods, or little luxuries like a trip to London or Paris.
To put this in wonky economic terms, the number of European vacations that Americans are buying is still going up (import volumes are rising). And the amount Americans are spending on each European vacation is also rising (import prices are up). So America’s import bill -- volumes*prices -- is increasing very rapidly. Evidence that import volumes are still increasing rapidly is why I have trouble figuring out why some forecasters (including the some big forecasters, like Macroeconomic Advisors) are suggesting that the trade deficit is likely to fall this year.
Say oil stays in the low 40s. The US oil imports would rise modestly, on the back of rising volumes. Look at this chart from Mr. Yglesias. It seems that domestic oil production has been on a slight downward trend since the mid 80s, and it certainly has not kept pace with US demand. The chart may not help with forecasting global oil prices, but it does give some indication of future US oil imports. Rising volumes and constant prices = a bigger bill.
Say the US grows in real terms at about 4%, and in nominal terms at 6% (The Macroeconomic Advisors forecast, from last week’s Wall Street Journal, in broad terms). The standard elasticities for imports are in the 1.7 to 2 range. In concrete terms, that means a 1% increase in nominal GDP leads to a 2% increase in imports. 6% growth then translates into a 10-12% increase in imports. In principle, it would be better to do everything in real (volume) terms and to have a separate import price forecast - but that takes a bit more time!
In 2004, US nominal GDP probably increased by around 7%, so an elasticity of two predicts nominal import growth around 14% -- not far from the observed 15% y/y increase. The falling dollar in 2003 did not exactly slow import growth in 2004. Until the falling dollar leads to lower import volumes, it won’t reduce our import bill ... until now, the falling dollar seems to have had a modest impact on import prices, and virtually no impact on import volumes.
If imports increase at 12% y/y, exports need to increase by 18% or so just to keep the trade deficit constant -- and by more than 20% to bring about major improvements. Exports are growing fast right now, almost 13% y/y. The dollar’s fall v. the euro in 2003 clearly helped 2004 exports, and the world economy was very strong in 2004. But recent monthly data suggest US export growth is slowing, and the world economy is expected to cool off a bit this year. Export growth of 10% seems possible, 15% feels like a stretch, and 20% strikes me as implausible ...
Because the US imports so much more than it exports, the math just works against the US. If imports and exports both grow at 10% in 2005, the trade deficit increases by $60 billion, if both grow at 12%, the trade deficit increases by roughly $75 billion. And, if -- as seems likely based on current trends -- imports grow at 12% and export growth slows to 10%, the trade deficit would rise by about $100 billion, to a bit more than $700 billion.
We will have another data point to mull on Wednesday.