Sunday, July 6, 2008

Has the United States lost its heavyweight title?

Aunt Jane, my newest fan, asked a great question regarding U.S. international trade. I am happy to respond to her comment from one of my earlier posts, Wall Street and Borrowers with Low Credit Ratings Have Been Bad.

Aunt Jane writes: “The USA currency is suffering and we no longer have the advantage in world trade. We are now in the beginning of the downslope that was predicted about 10 years ago with the emergence of China. How can we recover our advantage in world trade?”

That is an interesting thought, recovering a lost advantage in world trade. There are many answers to this question, but here’s the point that I will attempt to make below.

Key data do not indicate that we have lost a strategic advantage at all.

  1. Import prices have remained steady in spite of a tumbling the U.S. dollar (USD) since 2002; only recently have import prices started to climb, underscoring the strong incentives to pass on the recent surge in energy prices.
  2. Amid a sharp decline in the USD recently, foreigners are still snatching up U.S. stocks and bonds. This insatiable appetite for U.S. equity and debt has not subsided.
  3. The U.S. is not alone in its economic struggles. Driven by the falling USD, export growth is rising, which is pushing us through some very tough economic times.

In economic terms, “advantage” refers to the U.S.’s ability to produce something at a lower cost than can another country. In theory, it is this advantage that describes the directions of trade. However, since Jane refers to the U.S. dollar (USD), it is likely that she is addressing more of a “strategic advantage.” Many countries target the U.S. for export and are happy to sell to U.S. customers at reduced prices (usually by means of a currency peg) or giddy to acquire U.S. debt by the truckload.

As outlined in Reuters on July 5, the recent drop in the USD topped Bush’s policy agenda. However, the value of the USD has been falling quite precipitously since 2002, but only recently have import prices begun to rise. Theoretically, if the U.S. did not have a strategic advantage in world trade, then foreign producers would be more inclined to raise prices well before 2008.

Toshiba (a Japanese firm) ships a computer to the U.S. and is paid in USD by the U.S. customer. In order for the revenues to be of any use in Japan, Toshiba must trade the USD for Japanese Yen, and if the USD loses value relative to the Yen, then Toshiba’s revenues fall. Toshiba should raise its prices (raise the import price to the U.S. customer) in order to account for reduced USD value, and revenues remain unchanged.

However, Japan and other Southeast Asian economies like China depend on U.S. import demand for their goods, a term coined “coupling.” The U.S. is like the holy grail of economic growth for Japan and China, where each sell 20% of their country’s exports to the United States. Foreign firms are very reluctant to raise prices to the U.S. because U.S. consumers are sensitive to price adjustments. In the end, foreign firms will “eat” the costs of a falling USD for as long as they can.

Only recently have import prices excluding energy begun to rise. In May, the USD fell 9.4% on average over the year, but import prices only rose 6%. Given that energy costs are off the charts and the USD continues its decline, foreign producers are restrained in their price setting behavior.

In this light, I deduce that the U.S. still has a strategic advantage in world trade.

The U.S. dollar has been tumbling, U.S. economic growth is sluggish at best, the U.S. government is running budget deficits, and still foreigners acquire U.S. stocks and bonds. The chart below shows the net-foreign acquisition of all U.S. long-term securities (stocks and bonds) – the difference between how many U.S. securities foreigners bought and how many foreign securities the U.S. bought. Since the beginning of the year, when all of the U.S. turmoil really got going, the net-foreign assets position is positive ($115 billion) and rising.

If the U.S. was not strong compared to the rest of the world, then foreigners would sell off U.S. assets like a scalper in the second half of a football game. In fact, just the opposite is occurring. Amid all of the U.S.’s current economic pitfalls (and there are many), foreign investors, governments, and central banks are hoarding U.S. assets. This is a good thing, especially when the U.S. is just skirting a recession….barely, and only for now.

The U.S. economy is not alone in its economic struggles. The world, from Europe to South America, to Asia, to Australia, is battling higher fuel costs and inflation pressures. The U.S. stock market is now officially a bear market, and the USD continues its decline. It seems like many of the world’s stock market indices are competing in a chariot race to see which one can drop the quickest. According to the Fundmastery Blog, the Shanghai stock exchange is down more than 50% off its high. Foreigners are running away from Chinese assets like a cat in a thunderstorm. MarketWatch reports that the Japanese Nikkei is down 10 days in a row, its longest losing streak since 1965. The Financial Times reports that the FTSE 100 (London) slammed into bear territory on Thursday (July 3).

The U.S. is not alone, and the data indicate that the U.S. still has a strategic advantage. Import prices have only recently begun to rise and foreigners continue to snatch up U.S. securities.

We just brushed the subject of international finance. Be like Aunt Jane: If you have any further questions or comments, please write a note below. I will respond with an answer.

Thank you Aunt Jane!

1 comment:

  1. Great answer - you are a teacher at heart! Have not heard about the Shanghai exchange down trend or the flight from Chinese companies. Like I said before, we are probably on the upswing right now since everyone is pessimistic. Nothing like a contrarian! Janie


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