Felix Salmon Asks

So export growth is slowing, even as imports are rising again, despite the dollar only getting weaker over the course of the quarter.

To which I leave a comment: "J Curves". I\’ve now been asked to explain myself. Ahem.

Here.

Essentially it\’s a real world example of that folk wisdom, that things get worse before they get better.

The shape of the trend of a country’s trade balance following a devaluation. A lower exchange rate initially means cheaper exports and more expensive imports, making the current account worse (a bigger deficit or smaller surplus). After a while, though, the volume of exports will start to rise because of their lower price to foreign buyers, and domestic consumers will buy fewer of the costlier imports. Eventually, the trade balance will improve on what it was before the devaluation. If there is a currency appreciation there may be an inverted J-curve.

Following the depreciation / devaluation of the currency the volume of imports and exports will remain level due in part to pre-existing contracts for imported goods that have to be honoured. However, the depreciation will cause the price of imports to rise and therefore total spending on imports will subsequently increase. It is this that causes the worsening of the current account.

That Wikipedia entry is actually pretty good there. There\’s a great deal of speculation about the actual shape of such a J Curve, about how long it all goes on for, but the basic point sticks. It\’s not "despite" the dollar only getting weaker over the course of the quarter, it\’s "because " ditto ditto that export growth in cash terms is slowing even as imports in cash terms are rising again.

As well as pre-existing contracts, there\’s another contributor, that it takes time for people\’s behaviour to change. As an example, we\’ve been buying a certain material from Russia for the past 12 years. We\’ve just switched to a US supplier as a result of the changes in the rouble/dollar rate: about 9 months after it first would have been cheaper to do so.

Those J Curve effects do disappear though, in time. One thing that can delay them doing so though is that the currency declines again, leading to another such J dropping into our trade statistics. And if before that one has worked its way through the system, like a pig through a python, it drops again…well, you get the picture. Eventually of course the longer term effects overcome even a succession of J Curves and the trade balance comes roaring back.

As I fully expect the US one to, indeed, I\’d be really rather surprised if in 5 years time the US wasn\’t running a trade surplus.

6 comments on “Felix Salmon Asks

  1. I think you’ll find that things will get worse before they get very much worse.

  2. ‘As I fully expect the US one to, indeed, I’d be really rather surprised if in 5 years time the US wasn’t running a trade surplus.’.

    But.

    China is locked in to USA debt, despite their threats to change currency. And, even as I am typing this I am beginning to understand where you are going. Are you saying that, and I understand this from one point of view, China is too late in threatening to change exchange currencies and Bush has outplayed them?

    If so: neat.

    STB.

  3. Trade surplus – that’d be the first since 1976?! There was a quarter of surplus on the current account in the early 1990s though.

    Tim adds: I agree, it’s a rash prediction (which is why it’s hedged) but I would be surprised. The euro over $1.50? The £ at 1.95 or so? In the medium to long term trade flows are pretty much determined by relative prices. I really am seeing this in the metals business: we’re all buying from there, not selling to there now.

  4. scotsToryB,

    It’s not about China…well it is in part (of course), but USA is only the captain of one economic ship…its own (though it’s a darn big ship).

    Tim’s argument is totally correct, and explains the query Felix had. Put another way, currency changes are far more liquid than changes in trade of physical goods and should be expected to react more quickly to short term patterns.

  5. “… things get worse before they get better.”

    I would say its stronger than this – things have-to get worse before they get better. Which is why essential reforms are almost always delayed (eg. measures to curb-hyper inflation).

    And, with respect to J-shaped curves you might add: the longer a reform is delayed, the deeper the down-tick (the worse the worse-ness will be).

    So you get each government delaying inevitable reforms (eg. to pensions) because they don’t want to be blamed for the immediate harm -

  6. “… things get worse before they get better.”

    Yes but I would say its stronger than this – things *have-to* get worse before they get better. Which is why essential reforms are almost always delayed (eg. measures to curb-hyper inflation, or a house-price bubble – everyone knows what to do, and that it needs doing, but nobody wants to be the one to do it – because of being blamed for immediate harm).

    And, with respect to J-shaped curves you might add: the longer a reform is delayed, the deeper the down-tick (the worse the worse-ness will be).

    So you get each government delaying inevitable reforms (eg. to pensions) because they don’t want to be blamed for the immediate harm – and the longer the inevitable reform is delayed they worse the inevitable harm becomes. Eventually there is a big crisis, which was – in principle – avoidable.

    Sadly, politicians are quite correct to worry that they will be blamed for immediate harm but not-credited for longer term benefits.

    Margaret Thatcher’s economic reforms in the UK were hugely beneficial to the country in the long-term, reversing many decades of relentless economic decline and elevating the UK (for a while) to being the fourth most productive economy in the world.

    But ‘Thatcherism’ is remembered by most UK people for the (inevitable) short-term harm these reforms inflicted initially. The economic benefits were either not noticed (since they built up slowly over several years) ; or else they were (wrongly) credited to other factors.

    I can’t see things improving until some government drills it into the electorate that any beneficial change – beneficial overall and in the long term – nevertheless inevitably causes some harm to some people for some time. That’s life.

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