Time to Recalculate Dollar’s Value
In the year and a half since the dollar began its slide, what appears to be a greater than 30% drop in value against foreign currencies (as measured by the Federal Reserve’s trade-weighted index) is really a decline of little more than 4%.
The dollar has not fallen uniformly against all currencies. Rather, it has dropped sharply against a few, held steady against others, and actually risen against some others. Accordingly, the U.S. trade deficit not only has failed to narrow, it has continued to widen.
It would appear that a new calculation of the dollar’s foreign-exchange value is called for. The Federal Reserve’s index does not seem to be painting a realistic picture of what has happened to the dollar against the currencies of our most important trading partners.
For one thing, the currencies in the Fed’s index belong to those countries whose total worldwide trade--not just trade with the United States--was the largest in the years 1972 to 1976.
However, in order to measure the potential impact of the dollar’s depreciation in foreign exchange markets on our trade performance, a trade-weighted index should include the currencies of those countries whose trade is currently most important to the United States. This is especially true now, since the countries whose currencies have increased against the dollar over the past 18 months are chiefly the industrial countries of Europe and Japan.
The dollar has declined by an average of 34.5% against the currencies of these countries--but they only account for 38.5% of our trade. To get a truer picture of the trade-weighted value of the dollar, it is necessary to take into account--and give proper weight to--the currencies of a number of other countries.
Thus, my colleagues at Manufacturers Hanover and I have constructed an index based on the currencies of this country’s 17 largest trading partners in 1985, weighted by their share of U.S. trade (exports plus imports). This index finds that the dollar, besides having declined by little more than 4% from its February, 1985, peak, has actually risen by an average of more than 11% since then if currencies of our top seven trading partners alone are considered. These seven account for 61% of U.S. trade and 75% of the trade deficit.
Comparing the Federal Reserve’s trade-weighted dollar with the Manufacturers Hanover trade-weighted dollar, several observations stand out:
- The Fed’s index is based on trading patterns of the mid-1970s, while Manufacturers Hanover’s is based on last year’s.
- The 10 countries included in the Fed’s index accounted for little more than half (57.8%) of total U.S. trade in 1985, while this country’s 17 largest trading partners whose currencies are included in the Manufacturers Hanover index accounted for nearly 80% of total U.S. trade last year.
- The U.S. dollar has depreciated against every currency in the Fed’s index except the Canadian dollar, against which the U.S. currency has appreciated slightly. However, the U.S. dollar has risen against the currencies of six of our 17 largest trading partners while remaining virtually stable against two others.
- While the West German mark is the most heavily weighted currency in the Fed’s index, Germany’s share of U.S. trade in 1985 was only 5.3%, virtually the same as in 1975. Germany is only our third-largest trading partner. An index that gives the mark the heaviest weight is not a true representation of U.S. trade patterns.
- The Fed’s index completely excludes the newly industrializing countries of Southeast Asia--Taiwan, South Korea, Hong Kong and Singapore. The U.S. trade deficit with these countries has soared from less than $500 million in 1975 to an annual rate of nearly $29 billion so far this year, representing nearly 17% of the U.S. current trade deficit.
- Of this country’s 17 largest trading partners whose currencies are included in the Manufacturers Hanover trade-weighted index, three are from Latin America--Mexico, Brazil and Venezuela. The U.S. is running trade deficits with all of them and the dollar has appreciated significantly against two of the three. None of these three countries’ currencies is included in the Fed’s index.
It seems pretty clear that in order to properly analyze and evaluate our trade position worldwide--and thus the outlook for the U.S. economy--it is necessary to look at a broader, more up-to-date index of the trade-weighted dollar than one provided by the Federal Reserve. The Fed’s trade-weighted dollar may be back down to 1981 levels--but ours is still as strong as it was two years ago, and remains 63% above July, 1980.
Therefore, it would appear that for the U.S. trade gap to narrow significantly, the dollar will not only have to fall further against those currencies where it has already declined but it also must drop against at least some of those currencies, where until now, it has been stable or still rising.
