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  • The Impact of a Rising Dollar Isn't so Clear

    John Manzella, The Impact of a Rising Dollar Isn't so Clear

    Since August 2011, the value of the U.S. dollar has continued to rise. In the past, a strengthening dollar meant imported sweaters from Bangladesh would be cheaper. In turn, it was anticipated that American retailers would buy more of them, boosting the trade deficit. On the export side, a rising dollar was a curse for an American producer, who’s overseas prices would go up pushing sales down. But today, the impact isn’t so clear.

    In 2013, $1.2 Trillion or 55 percent of all U.S. imports were not consumer goods from low cost countries, but imports of industrial supplies and materials ($681.6 billion) and capital goods ($554.5 billion), the Bureau of Economic Analysis reports. These sources of supply are used by American manufacturers to improve their products and make them more globally competitive.

    A rising dollar reduces the import price of these industrial supplies, materials and capital goods. When used in the production or assembly with domestically-sourced American goods for export, the lower cost of imported supplies often neutralizes the higher export price of domestic materials and components.

    This scenario is more common than many may think. Today, a company’s production and supply chains may stretch across the globe, connecting with dozens of other producers and suppliers. As a result, it’s not unusual for a California-based company to receive industrial supplies and materials from several Asian and Latin American firms, and in turn, incorporate those in production that is ultimately shipped to Canadian and European customers.

    When the dollar was declining in value, the general assumption anticipated higher priced imports, and in turn, a reduction in the trade deficit. But this did not occur.

    Consequently, the sophistication and complexity of today’s supply chains often mean more components and materials switch hands and incur value-added processes in different countries on their way to the final buyer. This process is quite different from the days when a product was entirely produced in one country utilizing all domestic inputs and exported to another.

    In addition to this web of co-production across borders, other factors play a greater role that, in turn, have made previous currency assumptions invalid. These include the decline in the pass-through rate, the availability of domestic and foreign substitutes, and opportunity costs of finding new suppliers.

    If, for example, the Chinese currency, the renminbi also know as the yuan, rises by 3 percent relative to the U.S. dollar, and Chinese exports to the United States also rise by 3 percent, the pass-through rate would be 100 percent. But today, exporters often are willing to reduce the pass through rate to preserve foreign market share. This being the case, a Chinese exporter may reduce his margins to neutralize the appreciation of the renminbi so the final price to American customers remains the same. This, no doubt, has an impact on old black and white currency assumptions.
    Over the past few decades, the value of the dollar has incurred a roller coaster-like ride. In March 1973, the Federal Reserve’s Nominal Major Currencies Dollar Index, a weighted average of foreign exchange values of the U.S. dollar against a number of currencies, was set at 100. It reached a high of 143.9 in March 1985, and fell to an all-time low of 69 in August 2011. Since then it has continued to rise, reaching approximately 79.8 in September 2014.

    Years ago when the dollar was declining in value, the general assumption anticipated higher priced imports, and in turn, a reduction in the trade deficit. But this did not occur.

    Between 2002 and 2005, the U.S. dollar depreciated 23 percent against the Canadian dollar and 24 percent against the euro, says Daniel Ikenson, Director of The Cato Institute’s Herbert A. Stiefel Center for Trade Policy Studies. However, during this period, the U.S. trade deficit with Canada and members of the Eurozone rose by 58 and 39 percent, respectively.

    The belief that China’s currency would rise if allowed to float doesn’t consider China’s current economic problems.

    In fact, Ikenson reported that of the other major U.S. trading partners, including Japan, the United Kingdom, South Korea, Taiwan, and Brazil, whose currencies appreciated against the dollar during the same 2002-2005 period, only Taiwan’s trade surplus with the U.S. declined — but only by a modest 8 percent. In contrast, the U.S. deficit increased by 18 percent with Japan, 22 percent with Korea, 71 percent with the United Kingdom, and 181 percent with Brazil.

    Many believe today that if China were to allow its currency to float, it would strengthen against the dollar making U.S. imports from China more expensive, and in turn, would reduce the mounting U.S.-China trade deficit. These assumptions are no longer valid.

    In July 2005, when China reportedly pegged its exchange rate to a fixed basket of currencies, one U.S. dollar could buy 8.28 renminbi. Years later on October 12, 2014, one dollar could only buy 6.13 reflecting a stronger Chinese currency. Nevertheless, during this period the U.S.-Chinese trade deficit has continued to climb.

    And the belief that China’s currency would rise if allowed to float doesn’t consider China’s current economic problems. In fact, if allowed to float, it may become volatile and decline in value due to China’s current financial issues and modest economic growth as compared to its stellar double-digit growth in recent years. And even if Chinese exports to the U.S. were somehow limited, U.S. importers would seek out other foreign suppliers of low-cost goods likely resulting in a still-large U.S. trade deficit.

    The bottom line: the rising or weakening dollar doesn’t necessarily have the same impact it once did. As a result, old assumptions need to be re-evaluated to account for today’s dynamic trade patterns.

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