Monday, January 29, 2018

Is Treasury Secretary Mnuchin Right About The Impact Of The Dollar On US Trade?

Maybe yes.

In Davos some days ago Treasury Secretary Mnuchin declared that a lower valued dollar would lead to a lower US trade deficit. The dollar promptly fell several percents and various persons and many observers reacted in horror, most prominently former TreasSec Larry Summers.  He did no actually dispute Mnuchin's claim factually, rather he asserted that people holding that position as he did should follow a strong dollar policy and talk it up, that a lower dollar raises prices of imports (true) and that advocating it is just plain irresponsible, even though his predecessor, Lloyd Bentsen, in the Clinton administration also talked down the dollar at one point as a job-increasing policy.

Dean Baker at Beat the Press responded to all this with two days worth of posts defending the factual basis of Mnuchin's claim against his critics (some of whom did not dispute his facts but rather argued the policy was unwise for other reasons).  He argued that indeed lower values of the currency leads to lower trade deficits, noting experience in the 1980s especially when a strong dollar led to a soaring o the US trade deficit that fed into a sharp decline in manufacturing employment in the US Rust Belt, with the deficit declining as the dollar fell after the 1985 Plaza Accord. He pointed out that a lower dollar lowers the price of US exports abroad, which tends to increase the quantity of exports, and raise the price of imports in the US (as Summers noted), which tends to decrease the quantity of imports.  All of this is indeed true, even if the size of those changes may vary a lot.

Over on Facebook, the secret godfather o this blog, Max Sawicky, reposted Dean's claims, which led the estimable data wonk and socialist critic of Wall Street, Doug Henwood, to demand of Dean to specify exactly how much exports would increase by country and by sector. Apparently he issued this initially on something called Cabalist of which I know nothing.  Apparently Dean did not reply to this request, which would have been very difficult to do in any detail with any degree of credibility.  He then criticized Dean (on Max's FB thread) quite strongly for not laying out the impact on income distribution of a fall in the value of the dollar, which I surmise was what he was really after with his question about a detailed breakout by country and sector of the claimed expansion of exports.  I gave Doug a hard time about him giving Dean such a hard time about this, which led Doug and some others to get vigorously on my case.  So, I think it might be worth laying out in more detail what is likely to be true in all this, given that it seems that a lot of people have taken to spouting hyperbolic nonsense about it.

The first thing that should be noted is that the simple claim by Mnuchin that Dean supported regarding the value of the dollar and the trade balance is not strictly true, although it mostly is. The caveat he should have noted is the well-known phenomenon of the J-curve.  If one graphs trade balance over time following a noticeable devaluation/depreciation of a currency, it often looks like the letter J, initially moving more into  deficit before turning around and moving more towards surplus, with that move usually overwhelming the initial move to deficit. In the immediate run a fall in the value of the dollar increase the trade deficit, but then decreases it in the middle and longer runs.  The reason for the initial increase in trade deficit is that price changes tend to happen faster than quantity changes.  So with no quantity changes, the lower price of exports lowers the value of exports, while the higher price of imports raises their value, thus making the overall trade deficit larger.  Indeed, it is possible for the changes in quantities to fail to overcome this worsening of the terms of trade, an old issue in international trade that even Alfred Marshall knew about, with the Marshall-Lerner condition holding for a fall in currency value to lead to a lowering off any trade deficit (basically sum of import and export elasticities of demand must exceed one, a condition that usually holds for most countries).

Where Dean is right, even if a falling dollar increases the trade deficit (making Mnuchin wrong) is that a falling dollar increases the volume of exports and decreases the volume of imports.  This means that one should expect in the reasonably near term for there to be an increase in employment in the exporting and import-competing sectors, even though consumers will be hurt by higher prices.  I do not know if Mnuchin made this narrower and more accurate argument than his broader more contingent claim about trade balances.

The matter of the income distribution impacts of all this is much more complicated.  On the import side it operates somewhat like protectionism, and in recent years it has been thought that imports have hurt labor incomes as compared with capital incomes, with increased trade having played a role in the rise of capital share in national income.  I am not certain that is the case, but it is widely believed, and it is certainly the case that at least some openings to trade have hurt manufacturing employment as documented by Autor et al recently regarding the outcome of China entering the WTO.  However, the impact of increasing exports from the US  seems far less clear than the impact of reducing imports, and I do not have even the beginning of an  answer, much less some generalization, despite Doug Henwood sneering at Dean Baker that he did not just pop up with one.  US exports have a substantial agricultural component as well as a substantial high skill labor component in software, films, and various services.  Perhaps Dean was looking at those later sectors and viewing their gains as helping out high income workers, although much of agricultural labor is quite low income, and to the extent that loweing imports helps lower to  middle income workers, that  further complicates the picture.  In any case, I do not see some clear or neat outcome regarding the income distribution impact of a lowering the value of the dollar.

Let me conclude that while I agree with Dean that lowering the value of the dollar may will certainly tend to increase the quantity of exports and lower the quantity of imports as well as tend therefore to increase employment somewhat, this does not mean that I necessarily support a "talking down the dollar" policy.  One obvious problem, mentioned by Summers, is that a too obvious and aggressive such  nationalist policy is likely to  call forth retaliation from other nations, just as an aggressively protectionist policy is likely to do.  They will start talking down their currencies and perhaps engage in more direct policies to lower their values, which can easily end up in a "beggar thy neighbor" war as described by Joan Robinson in 1937.  More often than not a wiser policy for a TeasSec is not to push either a strong or weak currency policy and just keep quiet, just as such a policy is often best for central bankers as well, even though the TreasSec is "in charge" of the dollar.  Sometimes asserting that authority is nothing more than a pointless macho exercise.

Barkley Rosser


ProGrowthLiberal said...

J-curves and Marshall-Lerner conditions do not fit very well on Twitter or Facebook. Nor do macroeconomic considerations. Which is why these discussions should be done on economic blogs and not Trump's twitter machine.

Barkley Rosser said...

While some of it has been on blogs (see Dean's original posts) some of it has been on other non-Twitter non-blog locations, such as Facebook. I am a bit frustrated with how Doug Henwood has treated this, making a lot of snarky remarks while offering zero of substance to support his sniping at Dean. As far as I am concerne, and I said so on FB, this is one of the poorest performances I have seen out of him, and he is someone I seriously respect and have for a long time, even as I have often disagreed with him in the past. But he needs to acknowledge that he behaved badly here. Instead he has descended to calling others names without offering a shred of substance to back up his abysmal and embarrassing conduct.

This is now public to you, Doug. Come here and explain your conduct and your arguments. You have not done so on FB or anywhere else that I know of, just called names and acted in a shameful manner. You need to explain yourself or publicly apologize.

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kevin quinn said...

What bothers me about the whole discussion is treating the exchange rate as exogenous. In a standard open-economy macro model with output in the neighborhood of potential output, an increase in net exports is matched by an increase an increase in saving, a decrease in investment, or some combination of the two - C or I or the two together fall by as much as NX increases. said...


You are right that forex rates are endogenous. However, it turns out that they do not behave like they are supposed to based on the theoretical models, indeed, they may be the hardest of all macro variables to model or forecast. A famous paper back in 1985 by Meese and Rogoff showed that a random walk model of forex rates beat a whole bunch of alternatives based on standard theory models. But, the big joke was that even the random walk model did a lousy job of modeling them, at best a very noisy random walk.

There have been some recent efforts claiming to do slightly better than random walk, although not by much, with Menzie Chinn who blogs at Econbrowser an excellent source on these. But even the best of these more recent models still perform very poorly.

dk said...

Hi Barkley,

Thanks for laying out the argument in more detail.

There's an estimate that more than half of our current trade deficit is due to tax shifting by firms with intellectual property (Guvenen 2017) which is mentioned here:

Is that plausible? If it's true or close, wouldn't that reduce the scope for any gains from a change in currency values?

Barkley Rosser said...


That is quite possible, although some of that shows up in capital account flows. It should be kept in mind that the US has not run a trade surplus for well over three decades now, with it even further back that we ran them regularly, which pretty much came to an end by the late 1970s. 1978 was the year of maximum employment in the US auto industry, which is a useful benchmark to keep in mind for much of these discussions.

At least part of our tendency to chronic trade deficits is due to our tendency to a capital account surplus due to the US dollar being not only the world's leading reserve currency but also the most widely used one for international transactions for both trade and capital movements. This issue has been around basically since around 1960 when the late Robert Triffin analyzed it.