US trade remedy slow to act, but the effect may prove dramatic
TWO months of improving trade statistics have made many observers hope the United States trade deficit is finally beginning to decline. If it is, it would largely be in response to the lower value of the US dollar in relation to other currencies. That is probably a correct observation, and one that we will dig into in just a minute. But to complete the picture, we must at least remark that there is also considerable anecdotal evidence - that is, specific company-by-company information - indicating that US production has been permanently shifted overseas during the 1980-85 era of dollar overvaluation.
The point is that things happen at the micro level - the level of the individual company - in response to what has been happening at the macro level, the level of overall fiscal and monetary policies. Those policies affect relative interest rates or the attractiveness of investment in one country vs. another. When macro policies change, they affect decisions at the level of the individual company. But it takes at least several quarters for this to work its way through the system.
One recent study strongly supports the notion that the US trade deficit is on its way to substantial improvement or perhaps even extinction. This is the work done by Brian Reading in London for International Advisory Associates. Mr. Reading notes the so-called J-curve effect, the time it takes for a currency depreciation to have a positive effect on a country's foreign trade. But he goes further, pointing out that the dollar's devaluation coincided with several events that had the effect of delaying even further the beneficial effects of devaluation.
First, it took place during a time of world overcapacity in production. This induced a country such as Japan to sell its manufactured goods abroad at greatly reduced profits to keep its own work force employed. Since the Japanese work force is on a substantial bonus system, workers shared in the decline in profits from exports. Moreover, many Japanese manufacturers were hedged with their currencies for some time into the future. Thus, the first several quarters of the decline in the dollar did not affect them as severely as the changed dollar-yen exchange rate would have suggested.
Furthermore, the decline in the dollar came at the same time as the decline in oil prices. These two factors resulted in much lower energy costs for the Japanese, which meant lower manufacturing costs.
What has happened now, Reading says, is that ``Japanese exports have lost their cushion of fat margins from the dollar's former excessive strength. Oil and commodity price falls will not be repeated, and may to a degree be reversed. Forward contracts will expire. From now on we shall see the weaker dollar having an increasingly noticeable effect on the US trade balance and on activity in Germany and Japan.''
Reading, with whom I spoke in London recently, also thinks the shift in the trade balance will be much more substantial than the consensus estimates. When there are major shifts, he says, economists tend to be timid in their forecasts. Given the decline in the dollar over the past 18 months, this is going to be a big shift when it comes. Within a couple of years, the trade gap may become a non-issue.
``Few people have the courage to project swings for the future of the magnitude observed in the past,'' he says. ``It is thus a fair bet that when a turn is predicted, as it is this year for 1987, it will in the event be far more violent than forecasters predict.''