Why Weak Currencies Have a Smaller Effect on Exports – By PAUL HANNON
As various central banks loosened monetary policy this year, some economists predicted another cycle of beggar-thy-neighbor currency wars, in which countries race each other to become the cheapest exporter.
But it hasn’t panned out that way, and now a growing body of evidence suggests why: A shift in trade dynamics is blunting the impact of a weak local currency.
This could be all the more relevant now, when the monetary policies of the world’s most powerful central banks—the Federal Reserve and the European Central Bank—are heading in very divergent directions, possibly taking the value of their currencies along with them.
When a country loosens its monetary policy, interest rates fall and investors tend to pull their money out in search of higher yields elsewhere, pushing down the currency’s value.
That is still happening. But the dynamic isn’t affecting trade flows as much as expected. What has changed is where businesses source the things they need to make the products they export. Manufacturers once found most components needed to make their goods at home. Now they increasingly look abroad for such inputs. As a result, exports now incorporate a lot more imports.
It is still the case that when a currency such as the euro weakens, it reduces the price of goods sold by German manufacturers in the U.S. But it also increases the price of the things that German manufacturers import to make those exported goods.
Measuring the impact of global supply chains on trade flows is the task of a project undertaken by the Organization for Economic Cooperation and Development and the World Trade Organization.
Using detailed figures from economies around the world, economists at the two bodies have measured how much foreign content there is in each nation’s exports, confirming a significant increase since the mid-1990s. The foreign content of Switzerland’s exports, for instance, increased to 21.7% in 2011 from 17.5% in 1995, while the imported content of South Korea’s exports almost doubled, to 41.6% in 2011 from 22.3% in 1995.
Economists at the International Monetary Fund and the World Bank have used those measures to assess whether currency movements have the same impact they once did on exports and imports. They found that the effect has in fact reduced over time, by as much as 30% in some countries.
Policy makers are beginning to take note. “As countries become more vertically integrated via global value chains, exchange-rate variations will have a diminishing impact on the terms of trade,” said Benoît Coeuré, a member of the European Central Bank’s executive board and one of its thought leaders, speaking in California last month. He concluded the process will reduce the role of currency moves as “shock absorbers” that direct global demand toward weaker economies from stronger ones. Read More