Trade Deficits and Devaluation

“Record” seems to be the favorite term for CNN of late: household wealth yesterday and record export demand today. It is true that exports have risen in nominal terms and are even higher than they were in 2000 after adjusting for inflation. Exports, however, are only 10% of GDP now versus 11.2% for 2000. BEA’s National Income Accounts also report that the import GDP ratio was 15.2% in 2004 versus 15.0% for 2000. To suggest that the increase in the trade deficit is mainly due to stronger import demand is misleading.

Even more misleading is the critique of “Keynesian reasoning” as well as Warren Buffet in this oped being touted among the rightwing econopundits. Why would anyone suspect a stable correlation between a nominal exchange rate and the trade deficit? In fact – under floating exchange rates, there is no more reason to expect any particular correlation between the real exchange rate and the deficit than to expect a stable relationship between the price and quantity of any good determined by demand = supply forces. Not to harp on the Mundell IS-LM model again, but does it not predict that fiscal restraint (stimulus) leads to a weaker (stronger) dollar and trade surpluses (deficits)? Wasn’t this the dominant shock during the first Reagan term?

Other bloggers have been noting recent Asian Central Bank mercantilism, which is a point I have not given sufficient credit to, but should. Effectively, the exchange rate regime is like a system of price controls creating either excess demand or supply depending on which nation’s perspective you take. I wonder if Mr. Buffet said that relaxing rent controls in San Francisco would alleviate the apartment shortage or lowering the real value of the minimum wage would lower unemployment. Would the rightwing call him an idiot for saying that?