Since currency manipulation looms so large in Congress’ likely upcoming debate on President Obama’s new trade deals, the release earlier this week of government data on import prices for full-year 2014 couldn’t be better timed. They’re especially informative regarding the President’s planned Pacific Rim agreement, the Trans-Pacific Partnership (TPP), because Japan and other prospective members have been major currency manipulators. And if the agreement is completed and ratified, the inclusion of China – a master manipulator – can’t be far off.
The import price data reveal how much goods made abroad are sold for in the U.S. market. Because currency manipulation policies affect the prices of all the manipulator economy’s products, and because the issue has attracted so much attention in Washington, you’d think that there would be a strong relationship between manipulated exchange rates and these import prices. But in recent years, that relationship has sometimes been elusive.
Japan illustrates the problem. From 2011 to 2012, (using the end of the year as the baselines), the yen depreciated by a modest 1.25 percent versus the U.S. dollar. That year, the prices of Made in Japan manufactured goods (virtually Japan’s only exports to the United States) in the American market actually rose by 0.59 percent. By comparison, the overall prices of U.S. manufactures imports dropped by 0.51 percent.
Early the following year, new Japanese Prime Minister, Shinzo Abe, set economic policy on an explicit weak-yen course. Japan’s currency that year fell by 21.48 percent against the dollar, and prices of U.S. imports from Japan in 2013 fell by 3.40 percent. That was a much steeper drop than that experienced by the prices of all U.S. manufactures imports (1.36 percent). The continuation of “Abenomics’” weak-yen policy drove the currency down another 13.87 percent against the dollar in 2014. Yet import prices declined by much less – only 1.41 percent. This decrease was virtually the same as the decline in the prices of all America’s manufactures imports (1.38 percent).
Keep in mind that the explanation here can’t be the so-called J-curve effect. That notion holds – pretty persuasively – that when a currency weakens, an early effect is to increase that country’s trade deficit. The main reason: Consumption patterns don’t change overnight, and the weak-currency economy initially keeps buying foreign goods even though they’ve become more expensive. But we’re not talking about trade flows here – just the prices of imports.
The relationship between import prices and exchange rates is even harder to discern for China. Between 2011 and 2012, the prices of China’s (manufacturing-dominated) imports in the American market fell by 0.57 percent. That was slightly more than the 0.51 percent decline in the price of all foreign manufactures bought by Americans. But the yuan strengthened versus the dollar by 1.01 percent that year.
Between 2012 and 2013, the yuan rose against the dollar by much more: 2.83 percent. Yet the prices of Chinese manufactures sold in America fell faster: by 0.67 percent. At the same time, overall U.S. manufactures import prices, however, did drop by about twice as much as Chinese prices – 1.36 percent.
Last year, the yuan resumed weakening against the dollar: by 2.49 percent. Yet the prices of China’s imports slipped a mere 0.10 percent – much less than the 1.38 percent price drop for all U.S. manufactures imports.
It’s always vital to remember, though, that exchange rates aren’t the only determinants of import prices. The different growth rates – and demand levels – of economies matter crucially as well. So, as a result, do government policies that affect these demand levels – like tax rates and incentives and fiscal and monetary policy that’s not aimed at exchange rates.
Changes in the make up of trade flows mustn’t be overlooked, either; countries can move into more expensive manufacturing sectors from less expensive ones, and are constantly trying to do so. Various types of government industrial subsidies and incentives are major influences on prices, too, whether they’re legal according to trade agreements or not (as I noted in this recent post).
It’s also important to remember, as I’ve noted previously, that the movement of one currency versus another over a certain time frame has little to do per se with whether that moving currency is becoming more or less fairly value. Currencies like the yen and yuan can be undervalued even after periods of strengthening if Japanese and Chinese economic fundamentals are strengthening even faster, and especially if their governments keep actively buying and selling dollars in foreign exchange markets – which significantly affects the prices of those currencies versus the dollar. And it’s even more important to remember that China’s government barely permits any trading in the yuan.
So even though import prices by no means move in lock step with currency values, there can be no doubt that exchange rates and their movements are big parts of the price picture. Moreover, manipulation affects these prices for reasons having nothing to do with free markets of free trade.
As a result, a Trans-Pacific Partnership agreement without strong, enforceable measures against currency manipulation would, as critics warn, be a major blow to U.S. economic interests. But because of all the other ways in which governments can change the prices and competitiveness of traded goods – and rig trade flows to their advantage – it will take much more to make the TPP into a winner for America.