Fitting Into the Global Economy

 

With the dollar's decline and the increasing role that export growth has played thus far in offsetting much of the decline in housing markets, now may be a good time to take another look at the position of the United States in the global economy and the implications of  that position for America's citizens, businesses, and policymakers.

 

The dollar has fallen sharply against most major currencies and is currently at, or near, all-time lows against many of them. One broad measure of the exchange rate, the trade-weighted dollar, which measures the dollar's value against a weighted average of the world's major currencies, was down 12% from a year ago through April 2008 and has fallen more than 35% since highs in 2002.

 

 

But the dollar's fall has not been evenly distributed across our trading partners. With a few notable Asian countries actively manipulating their currencies, the dollar's fall has been more pronounced against European and North American trading partners.

 

For example, relative to the euro, the dollar has fallen 16.6% over the past year and 81% from its peak in 2002. The trend is similar, though less pronounced, for our other trading partners. In the last year, the dollar has declined by 11% against the Canadian dollar (affectionately known as the loonie) and recently traded at a discount to the loonie for the first time in nearly 30 years! The dollar declined by 13.7% against the yen in the past year as the U.S. government has spoken out against perceived manipulations, but it only dropped 25% since 2002. Against the Chinese yuan, the dollar has fallen by 15% since 2002, with 9.4% occurring in the past year, as the United States has brought pressure on the Chinese government to stop its overt manipulation.

 

Exchange rates influence the trade balance by changing the relative prices of domestically produced and imported goods and services. A strong, or appreciating dollar, raises the price of exports and lowers the price of imports. By contrast, a weak, or depreciating, dollar raises the price of imports and lowers the price of exports. Therefore, a stronger dollar tends to increase imports and lower exports, thus increasing the deficit. A weak dollar does the opposite.

 

As such, the recent declines in the dollar have been a major factor in the improvement in the trade balance over the past few years. In the last year alone, exports have grown by 9.5% ($130 billion) to nearly $1.5 trillion, offsetting much of the drag on the economy from the debacle in the housing market.

 

By comparison, imports have grown very slowly over the last year, rising only 0.6%, an increase of only about $13 billion, and currently stand at about $1.9 trillion. Taken together, these forces have significantly trimmed the trade deficit. In the last year, the trade deficit has declined 19% to $495 billion from about $612 billion a year earlier.

 

More detailed data on the trade picture are available from the International Monetary Fund. In terms of total goods trade, our largest trading partners are the EU, Canada, Mexico, and Japan. Trade flows increased among these countries in the past year, driven by U.S. exports. Also, it is worth noting that while China still does not rank among the top three trading partners of the United States, the level of trade between China and the United States has grown rapidly in recent years, and 2007 was no exception.

 

While our exports have increased recently, we should point out that we are still running trade deficits with most of our trading partners. For example, in 2007, the latest available data, the United States had net export positions of -$103 billion, -$96 billion, -$66 billion, -$39 billion, and -$178 billion with the EU, Canada, Japan, Mexico, and China, respectively.

 

Let's take a closer look at the type of goods we export and import. For 2007, our primary exports to the rest of the world were transportation equipment, $215 billion; computer and electronic products, $188 billion; chemicals, $151 billion; and nonelectrical machinery, $131 billion.

 

On the other side of the ledger, our biggest imports were computer and electronic products, $315 billion; oil and gas, $285 billion; transportation equipment, $282 billion; and chemicals, $152 billion.

 

In addition to goods and services, capital also flows across international boundaries. The international financial account is a record of transactions between U.S. residents and foreign residents resulting in changes in the level of international claims or liabilities, such as deposits, ownership of portfolio investment securities, and direct investment. This data measure the investment position of a country and give an indication of indebtedness. In 2006, the latest available data, U.S.-owned assets abroad were $13.8 trillion, and foreign-owned assets in the United States were $16.3 trillion. Therefore, the United States was a net borrower from the rest of the world to the tune of $2.5 trillion.

 

One component of these international accounts that often receives a major emphasis in the press is foreign direct investment (FDI). In short, FDI represents how many real productive assets our citizens own abroad and how many of our real productive assets are owned by foreigners. In the United States, the criteria used to distinguish FDI from other types of investment are ownership of at least 10% of the voting securities of an incorporated business enterprise or an equivalent ownership interest of an unincorporated business enterprise. FDI in the United States totaled more than $1.8 trillion in 2006. The stock of U.S. direct investment abroad totaled $2.4 trillion.

 

Because a greater percentage of our total investment abroad is in the form of direct ownership of productive assets (FDI) and foreign ownership of U.S. assets is predominately securities, many of which are Treasury securities, we receive a greater rate of return than foreigners. In 2007, income receipts on U.S.-owned assets abroad totaled $782 billion, whereas income payments on foreign-owned assets in the United States were only $707 billion, despite much higher total investment.

 

It may be useful here to take a look at which of our major trading partners invests more here than the United States does in their countries (positive net U.S. FDI), and in which countries the United States invests more than that country invests here (negative net U.S. FDI). Among our major trading partners, net U.S. FDI was positive with the EU (+ $7.5 billion) and with Japan (+$9 billion) in 2006. We experienced negative net U.S. FDI with Canada (-$8.2 billion), Mexico (-$8.3 billion), and China (-$4.9 billion).

 

While trade has clearly helped the U.S. economy weather the recent slowdown, the real long-term benefits are much more important. Trade generates considerable consumer surplus and supports 22 million U.S. jobs. Unfortunately, trade has recently come under fire in Congress and on the campaign trail, and a free trade agreement with Colombia is currently stalled in the House of Represen-tatives. We must work to lower trade barriers, reduce onerous regulations, and reduce the burden of taxation on American companies so that we can more effectively compete in an increasingly interconnected and competitive world.