Weaker Dollar Strengthens U.S. Agriculture
The depreciation
of the dollar has helped lift U.S. agricultural
exports to record-high levels, despite the gains
falling short of their full potential.
Mathew
Shane and William
Liefert
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The
depreciating U.S. dollar combined with
strong economic growth in developing
countries has increased the competitive
advantage of U.S. agriculture and stimulated
export demand for U.S. agricultural
products. |
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Despite
depreciating against currencies of some
U.S. trading partners, the dollar has
been largely fixed against currencies
of others, such as China, reducing potential
gains in competitiveness. |
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Trade
policies and imperfect markets can also
reduce the effects of depreciation,
further diminishing the gains. |
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Between February 2002 and May 2006,
the U.S. dollar depreciated almost 18 percent against
foreign currencies. While this depreciation has
helped boost U.S. exports to an all-time high, the
positive impact has not reached its full potential.
Even though the dollar has depreciated against the
currencies of some U.S. trading partners, it has
been roughly fixed against the currencies of other
key trade partners, thereby mitigating gains in
export sales. Trade policies and imperfect market
conditions in developing countries have further
cut into the gains realized from the depreciation
of the dollar.
The dollar has depreciated about
30 percent since 2002 against major developed-country
currencies, such as the Canadian dollar, the euro,
and the Korean won. But against other Asian currencies,
it has been a different story. Since 2002, the dollar
has depreciated 1.9 percent against the Malaysian
ringget and 4.7 percent against the Singapore dollar
and appreciated 5.2 percent against the Japanese
yen. In real terms, the Chinese yuan has appreciated
less than 1 percent against the dollar over the
same period. These modest changes partly reflect
policies of major Asian countries that keep their
currencies undervalued relative to the dollar and
thus do not permit a correction to trade imbalances.
Dollar Depreciation Usually
Stimulates Export Demand . . .
Since 1970, several substantial
periods of persistent appreciation or depreciation
of the dollar have mostly mirrored corresponding
fluctuations in U.S. agricultural exports. When
the dollar appreciates against foreign currencies,
U.S. exports cost more in foreign local currencies
and thus demand for them declines (see box, “Exchange
Rates Defined”). Conversely, a depreciation
of the dollar increases U.S. agricultural competitiveness
by lowering prices of U.S. products in foreign markets.
For example, the period 1970-80, a time of high
growth in U.S. agricultural exports, was accompanied
by a long period of depreciation of the U.S. dollar.
. . . but Impact Can Be
Blunted by Manipulation of Exchange Rates . . .
The decline in the U.S. exchange
rate since 2000 has helped boost U.S. agricultural
exports to an all-time high of close to $70 billion
per year. However, almost all of the depreciation
is accounted for by appreciation of currencies in
developed countries such as the European Union (EU),
Australia, Canada, and South Korea. Most developing
countries have followed policies of depreciating
their currencies in real terms against the dollar.
Developing countries’ commodities and goods
have thus become particularly competitive in the
U.S. market, while U.S. agricultural exports have
become more difficult to market in those countries.
As a result, these countries (mostly in Asia) have
generated substantial trade surpluses mirrored by
trade deficits for the United States. An underlying
reason for the large U.S. trade deficits is the
systematic undervaluation of developing-country
currencies and the funneling of those trade surpluses
into dollar-denominated financial and real assets.
China has pursued such a policy most persistently.
In 1978, when China began liberalizing
its economy, it followed the model of Japan and
Korea and pursued an export-led development strategy.
Between 1980 and 1995, China devalued the yuan against
the dollar in both nominal and real terms. The yuan
fell from 1.5 to the dollar in 1980 to 8.35 to the
dollar in 1995, resulting in a real depreciation
of two-thirds. Between 1995 and 2005, China maintained
a fixed yuan-to-dollar exchange rate of approximately
8.3. Only after accumulating nearly $1 trillion
in dollar reserves and with great political pressure
from the United States and the EU did China agree
to let its currency appreciate. However, while the
nominal value of the yuan has appreciated to around
7.9 to the dollar, the downward move has yet to
have any noticeable effect on Chinese export levels.
It is anticipated that China will allow some real
appreciation of its currency over the coming years,
although at a slow and measured pace.
An appreciation of the Chinese
yuan is even more critical to boosting U.S. exports
to Asia because most of the other Asian developing
countries, including Taiwan, Thailand, Malaysia,
Indonesia, and the Philippines, will allow an appreciation
of their currencies only if the yuan appreciates.
This policy was most likely shaped by the effects
of the Asian financial crisis of 1997-98.
. . . and Weak Pass-Through
to Developing-Country Markets
Imperfect markets in developing
market countries can also mitigate increases in
U.S. agricultural exports resulting from the depreciation
of the dollar. Exchange rates affect trade to the
extent that they can influence countries’
domestic prices for products, at both the producer
and consumer level, and thereby change the volume
of goods produced, consumed, and traded. For example,
if the U.S. dollar depreciates against other currencies,
consumers in other countries will be able to pay
lower prices for U.S. imports and will then buy
more U.S. goods. To remain competitive with the
imports, producers within these countries will have
to lower their prices, which, in turn, will lead
them to produce less. The degree to which changes
in exchange rates affect prices within countries
is called pass-through, or transmission. If an exchange
rate change has a strong effect on domestic prices
for products, the transmission is said to be high;
if the price effect is weak, the transmission is
low.
Weak (or low) transmission can
be a problem because it blunts the relationship
between exchange rates and countries’ domestic
prices. In the case of a depreciation of the dollar,
low transmission would weaken the price signals
for foreign consumers to increase their demand for
U.S. imports, and U.S. exports would decrease. Weak
transmission therefore works to cut countries off
from foreign economic interaction and world markets.
As a result, those countries do not maximize their
potential gains from trade.
A number of factors can cause
weak exchange rate transmission for agricultural
products. Governments often adopt policies that
reduce transmission. During the postwar period,
many countries, including the U.S. and the EU, have
pursued managed-price policies for many agricultural
products. The common feature of these policies is
that governments set domestic prices for products,
so that changes in trade prices or exchange rates
have little or no effect on those prices. Import
quotas can also hurt transmission. If a product
is subject to an import quota, a drop in the trade
price or exchange rate will not increase the quantity
of the good imported, which means the price or exchange
rate change will not affect domestic prices. Over
the last 15 years, however, under pressure from
the Uruguay Round Agreement on Agriculture of 1994,
the U.S., the EU, and other countries have significantly
reduced policies that either prevent or weaken price
and exchange rate transmission.
Low exchange rate transmission
also results from the weak market infrastructure
that often characterizes the broader food and fiber
systems in developing and transition economies.
Physical infrastructure, such as transportation
and storage, may be inadequate in developing countries,
and these countries also tend to lack market information,
rural credit, and commercial law adequate to enforce
contracts and protect property. Underdeveloped infrastructure
isolates regional markets within countries from
each other and cuts them off from the world market,
thus weakening the transmission of exchange rate
signals to domestic prices.
Empirical research indicates that
price and exchange rate transmission for agricultural
products is low in many developing and transition
economies, whether they are in Asia, Africa, Latin
America, or the countries of the former Soviet bloc.
One study that analyzed 56 developing countries
over a 30-year period found that about one-third
(18) experienced almost no transmission of changes
in agricultural trade prices to domestic prices,
even after allowing for an adjustment time of 5-7
years. This group includes such important foreign
markets as India, Bangladesh, Tunisia, Zaire, and
Colombia. In the other countries, after 5 years,
no more than half of the change in trade prices
was transmitted to domestic prices. This group includes
Pakistan, Indonesia, Egypt, and Venezuela. According
to ERS analysis of Russia’s transition from
a planned to a market economy during the 1990s,
trade price and exchange rate transmission for most
agricultural products in that country was between
25 and 50 percent. (A 100-percent transmission is
perfect, meaning that all of the change in the trade
price or exchange rate is transmitted to domestic
prices.) Although policies within the developing
and transition economies certainly account for some
of the weak transmission, poor market infrastructure
is also a major factor. While there is evidence
of some improvement in market infrastructure, suggesting
that price transmission might be improving, the
process of full market integration is one that takes
a long time to accomplish.
Other Factors Help Maintain
Demand for U.S. Exports
The depreciation of the U.S. dollar
since 2002 has helped improve U.S. agricultural
export performance, and this effect will likely
continue for some years to come. The rise in U.S.
exports, however, has fallen short of its potential,
due to fixed exchange rate policies pursued by China
and other key trading partners and weak transmission
of changes in exchange rates to domestic prices
in developing-country markets. China, in particular,
has only recently allowed its currency to appreciate.
Imperfect markets, on the other hand, would need
many years to correct, even if a determined effort
were made to overcome them. As a result, the conditions
that are reducing the benefits to U.S. agriculture
from a depreciating currency might be slow to change.
Yet, other longer term factors can help boost U.S.
agricultural exports. High income growth in developing
countries is the most important. However, pursuing
and maintaining high rates of productivity growth
in U.S. agriculture is equally important. These
two factors combine to create a strong potential
for the future growth in U.S. agricultural exports
regardless of how the exchange rate fluctuates in
the short to medium term.
| Exchange
Rates Defined
A nominal exchange
rate is the amount of one currency
that can be traded for another. Thus the euro
to dollar exchange rate is the amount of euros
required to purchase one dollar. For currencies
with flexible exchange rates, this amount
can fluctuate daily or even on an hourly basis.
This exchange rate is called nominal because
no attempt is made to adjust for inflation
in the two economies.
A real exchange
rate is a nominal exchange rate adjusted
to reflect changes in relative inflation in
the two economies. Thus, each nominal currency
is divided by some common price index, usually
the consumer price index (CPI). The base year
is arbitrarily chosen, and the real and nominal
exchange rates are set equal for this year.
For the exchange rates referred to in this
article, the base year is 2000. For economic
analysis, real exchange rates are preferred,
and therefore are used more often than nominal
rates.
Trade-weighted or
effective exchange rate indices are
average exchange rate indices across a group
of countries. Trade weights are derived by
taking trade for a particular commodity or
commodity group and converting it to shares
by dividing individual trade weights for a
particular country by the total across countries,
so that the weights add up to one. The trade
weights most often used are total merchandise
exports and total agricultural exports. Other
weights can also be used, such as country
exports to the world or imports. The exchange
rate index is derived by multiplying each
country exchange rate index by its relevant
trade weight and summing them.
An appreciation
of a currency occurs when the ratio of a given
currency declines relative to the reference
currency. In this article, the U.S. dollar
is the reference currency. Accordingly, the
euro is said to appreciate against the dollar
if fewer euros are required to purchase one
dollar, that is, if the euro exchange rate
goes from 1 to 1 to 0.8 to 1. A depreciation
of the currency occurs when the ration of
a given currency increases relative to the
reference currency, that is, the opposite
of an appreciation.
A real appreciation
(depreciation) of a currency occurs
when the inflation-adjusted ratio of a currency
declines (increases) relative to a reference
currency. A revaluation (devaluation)
is a situation in which the appreciation (depreciation)
occurs because of specific action taken by
a country. A real appreciation (depreciation)
can occur even if nominal exchange rates do
not change. This would be caused by differential
rates of inflation between a foreign country
and the United States. For example, if inflation
is greater in a foreign country than in the
United States, this would lead to a real appreciation
of the foreign currency even when the nominal
rates are fixed. In instances where high rates
of inflation are occurring in a foreign country,
and where the nominal exchange rate is not
being depreciated at the difference in the
rates of inflation, the nominal exchange rates
and real exchange rates move in opposite directions.
Such a situation occurred in Russia and Ukraine
between 1990 and 1992. |
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