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Business inventories and trade: the case of Japanese and German trade influence on America.

ABSTRACT

The American economy has experienced many problems from the stock market 'DOT.COM crash' of 2000-01, to high failure rates among financial institutions and a runaway national debt with growth reducing interest rates that are related, either directly or indirectly, to the negative imbalance in our national payments. The imbalance in the American payments situation has always been primarily the result of a nagging imbalance in trade, exports minus imports of goods. Since the other contributing factors, with the possible exception of tourism and direct business investment, will almost always be negative a positive trade balance is required in order to realize a positive payments balance.

The trend of net export data has become more negative since 1956. Changes in business inventories and final sales data, however, do not indicate any strong general trends over time. Average percent change in Japanese and German exchange rates lagged one year indicate substantial stability until 1973.

Information to help support the validity of these results was obtained using econometric testing. Simple linear regressions of the independent variables against each other were computed. The F, t, and R squared statistics fail to show any substantial relationships between each pair of independent variables, thereby supporting the likelihood that multicollinearity is not a problem in this model.

One critically important factor is the likely possibility that Japan and Germany will respond to the declining dollar with new trade and economic policies under pressure from American business partners and the U.S. Government. The Japanese will be reluctant to make major tariff concessions because of domestic political considerations. For example, the average Japanese family spends 50% of its annual budget on food, compared to 15% for the average American family, because of close political ties between the ruling party and domestic farmers. Outrageous tariffs on food commodities keep prices high by virtually destroying all foreign competition. The Japanese government will have to weigh the loss of domestic supporters against the growing trade problems with America and few governments favor foreign interests over domestic concerns. Only when

America puts pressure on Japanese businesses that sell in American Markets, in the form of tariffs or import quotas, to make concession will the picture change significantly.

Unfilled orders is a key variable that should most likely be incorporated into a model, which includes changes in business inventories as an endogeneous variable because of the impact of, unfilled orders upon inventories and foreign sales.

Net exports should remain an exogeneous variable in most models attempting to evaluate the impact of the trade deficit. Other factors such as high levels of personal savings, and greater reliance upon other nations in trade are examples of complicating factors that could influence U.S. net exports. Such complications could make net exports an exceedingly difficult variable to estimate. Foreign exchange rates remain the best possible independent variables for estimating net exports despite complications in U.S. data related to the demand for U.S. currency.

One variable, which could possibly enhance the trade deficit model, are the levels of U.S. and foreign interest rates. While decreasing U.S. interest rates stimulate the economy, high interest rates provide incentive to foreign investors. A U.S. response to rising foreign interest rates has been to permit the value of the dollar to decline. A gradual shrinkage of the trade deficit is likely to keep an upward pressure on interest rates.

INTRODUCTION

The American economy has experienced many recent problems from the stock market 'crash' of October 1987, to high failure rates among financial institutions and a runaway national debt with growth reducing interest rates that are related, either directly or indirectly, to the negative imbalance in our national payments. The imbalance in the American payments situation has always been primarily the result of a nagging imbalance in trade, exports minus imports of goods. Since the other contributing factors, with the possible exception of tourism and direct business investment, will almost always be negative a positive trade balance is required in order to realize a positive payments balance.

After World War II America benefited from a booming economy and a favorable trade imbalance due to the devastation of the war and the rapidly increasing productivity, particularly in the American farm sector. That bonanza began to fade rapidly in the late 1960's and soon turned into a negative imbalance as European and Asian economies rebuilt and became more prosperous. Americans, with their massive domestic market, continued to ignore the growing problems of an unfavorable trade imbalance. The size of the imbalance in trade grew along with the negative effects on the American economy. The oil crisis and inflation of the late 1970's and early 1980's helped focus attention on the problems associated with our trade dilemma, but as inflation eased Americans slipped back into their complacent posture and the problems escalated. The impact of trade on the American economy continues to expand. Americans must stop ignoring the destructive potential as well as the positive benefits that can be derived from a well-planned trade policy. While the U.S. has maintained a favorable balance of trade in agricultural goods the net export of manufactured products has remained negative. World trade has become more competitive as European, Asian and even South American nations have experienced an expansion of trade with traditional American customers like Japan and Western Europe.

The purpose of this study is to explore the relationships between changes in U.S. business inventories, changes in foreign exchange rates and U.S. net exports. The use of changes in foreign exchange rates of two important U.S. trade partners, Japan and Germany, was successful in demonstrating an inverse relationship between foreign exchange rates and changes in business inventories. Net exports of goods appear to have an inverse and lagged relationship with changes in final sales of goods. This quantitative analysis confirms the possibility that changes in business inventories and final sales of goods have a positive simultaneous relationship. Further research should make it possible to build upon this model for evaluating the impact of foreign exchange rates and the trade deficit upon the U.S. economy.

MAIN RESULTS AND CONCLUSIONS

After econometric testing for possible adverse effects of multicollinearity, heteroscedasticity and autocorrelation, the results of the simultaneous multiple linear regression analysis appear to have captured a quantification of the following hypothesized relationships.
CBI = [b.sub.0] + [b.sub.1]CFS + [b.sub.2]CE[R.sub.1]
 (5.83) (.34) (1.20)

CFS = [b.sub.0] + [b.sub.1]CBI + [b.sub.2]NEM
 (10.84) (.85) (.24)

CBI = Changes in U.S. business inventories of goods
CFS = Changes in U.S. final sales of goods
CE[R.sub.0] = Average percent changes in Japanese Yen and
 West German Mark foreign exchange rates
NEM = U.S. net exports of goods


The first goal of this study was to measure the quantitative impact of net exports and foreign exchange rates as exogeneous variables upon the key economic variables of changes in business inventories and the final sales of goods.

It was discovered that a low value of the dollar in the world marketplace, as measured by changes in foreign exchange rates relative to the dollar, proved to reduce the trade imbalance even though other domestic economic forces were working against the fall of the dollar. Foreign buyers can more easily afford to purchase cheaper American goods when currency markets reduce the value of the dollar. At the same time, as the value of the Japanese Yen and West German Mark advanced, relative to the dollar, our products became more precious to our own consumers as the relative prices of German and Japanese goods rose sharply, reducing demand for the more costly foreign goods.

There was some concern that the potency of the exchange rate factor on trade imbalance would be reduced by the fact that foreigners are often willing to hold dollars, regardless of their relative weakness or strength as measured by exchange rates, because of their international acceptability as payment for debts. This factor did not prove to be particularly important, at least with respect to trade with Japan and Germany.

One explanation for this phenomena is that Germany has rapidly increased its trade with Japan and as these two traditionally strong economies experience further growth in trade they have come to depend less on the dollar as a medium of exchange, since their own currencies have grown in stature as internationally acceptable currency. This results would mean that the Germans and Japanese have begun to treat our currency as they would any other causing the exchange rate to reflect a stronger and more direct impact on the buying and selling of goods between their nations and America.

Further investigation needs to be made concerning this phenomena since it is quite possible that other trade partners such as Formosa, Korea and Canada with close trade ties to America, but less internationally acceptable currencies, may be holding on to dollars with greater tenacity despite the strength or weakness of our currency in international exchange markets.

It would prove valuable to know if the German Japanese experience is unique, as the investigator suspects, or is the rule in trade between the United States and other countries since that will have impact on the choice and effectiveness of foreign trade policy. If the German Japanese experience were unique then it would help explain why exchange rates have not adjusted themselves adequately to eliminate our trade imbalance completely. On the other hand if the German Japanese experience proves to be the rule then that demonstrates that the dollar is not fulfilling its role as the international monetary standard.

It is also important to remember that even with the existence of free floating exchange rates the system is not entirely self adjusting because of international economic conditions and political barriers that prevent the mechanism from working with absolute efficiency.

The influence of exchange rates demonstrates a lagged and inverse relationship with changes in U.S. business inventories. A declining dollar should eventually stimulate the exports of manufactured goods, productivity and the inventory levels of manufactured goods.

It is suggested that changes in the foreign currency rates of Japan and West Germany have a substantial lagged effect upon increases or decreases in U.S. business inventories. The most obvious reason for this lag is that domestic considerations will have a much greater impact on American business inventories than trade considerations. Most businesses will be more immediately concerned with domestic inflation, consumer spending and consumer confidence indices than on international sales. Some trade dependent companies, which make up about 20% of all U.S. corporations, will of course be impacted immediately but most will not realize the effects of varied exchange rates until some time has passed and those changes begin to be reflected directly in the domestic economy.

Net exports of goods may have an inverse relationship with changes in final sales of goods. Due to increased competition, increases in final sales could possibly be stimulated when imports of goods increase. Goods such as foreign automobiles and microcomputer chips contribute to price wars in the United States.

The inverse relationship between exports and final sales of goods is most likely the reaction of domestic sellers to current domestic market trends. As domestic sales fall, and inventories rise, sellers, particularly those holding agricultural commodities, a crucial American export sector, look around for foreign buyers to take up the slack and exports increase, especially when favorable exchange rates make such deals attractive. The government often encourages this process to reduce its commodity purchase costs when faced with large surpluses of agriculture goods. On the other hand sellers faced with strong consumer demand in domestic markets are less concerned about finding foreign markets and exports fall, particularly if exchange rates make foreign sales less attractive.

Changes in business inventories have been found to serve as a key economic indicator, as shifts from investment to disinvestments in business inventories accounted for 60 percent of the shrinkage in aggregate demand for goods output during the four recessions (1948 1949, 1953 1954, 1957 1958 and 1960 1961). During the first year of four periods of expansion shifts from disinvestments to investment in stocks accounted for 58 percent of the increase in total demand for goods. Business firms with excessive inventories tend to provide greater incentives and reduce prices to increase sales, particularly when exchange rates prove favorable.

Final sales of goods are likewise a key determinant of inventory levels. Changes in demand for goods tend to cause alterations in production levels, which should influence inventory levels. As sales decline production schedules are adjusted downward reducing inventory levels. Changes in business inventories and final sales of goods are thus hypothesized to have a simultaneous relationship.

DETAILED FINDINGS

The trend of net export (NEM) data generally became more negative since 1956. Changes in business inventories (CBI) and final sales (CFS) data, however, do not indicate any strong general trends over time. Average percent change in Japanese and German exchange rates lagged one year (CE[R.sub.1]) indicate substantial stability until 1973.

High intercorrelation values are indicated between CFS and CBI and CE[R.sub.1]. The correlations of CFS and CE[R.sub.1], and CBI and NEM, however, are relatively low values. The initial quantitative indications appear to be favorable relative to any possible effects of multicollinearity.

Each equation of the simultaneous model excludes one exogeneous variable and is identified. Tables 1 and 2 show the results of the computerized two stage least squares computations. Each independent variable has the same sign as specified. The F test indicates apparent significance beyond the .05 level for each simultaneous equation. The one tailed t test of each coefficient in each equation indicates significance beyond the .01 level.

Information to help support the validity of these results was obtained using econometric testing. Simple linear regressions of the independent variables against each other were computed. The F, t, and R squared statistics fail to show any substantial relationships between each pair of independent variables, thereby supporting the likelihood that multicollinearity is not a problem in this model.

None of the Glejser and Modified Glejser tests indicate any signs of heteroscedasticity. The Durbin Watson statistics of 2.33 and 2.02 are both above their test upper limits and do not indicate any positive autocorrelation.

METHODS

A sample of twenty nine years of average quarterly data at seasonally adjusted annual rates from 1958 to 1996 was evaluated using four economic variables: (a) change in U.S. final sales of goods (1982 dollars in billions), (b) change in U.S. business inventories of merchandise (1982 dollars in billions); (c) U.S. net exports of merchandise (1982 dollars in billions); and (d) average percent change of Japanese and German foreign exchange rates lagged by one year. The MicroTSP 5.0 software package (10) and an IBM PC microcomputer were utilized to perform the econometric and regression analyses.

Data for years 1956 through 1996 were utilized in this study. Change in final sales (CFS) data was generated by subtracting the previous years value from that of the current year. Change in business inventories (CBI) data was directly available in the data sources. Net export (NEM) data was computed by subtracting merchandise import totals from export totals. Changes in Japanese and German foreign exchange rates lagged one year (CE[R.sub.1]) were computed using the following procedure: (1) conversion of cent/yen and cent/mark data to yen/dollar and mark/dollar rates, (2) computation of annual percent changes of yen/dollar and mark/dollar rates, (3) computation of simple averages of the annual percent changes of yen/dollar and mark/dollar, and (4) lagging each computed average by one month. Sources of the data for CFS and CBI was table B 7 of the _Economic Report of the President_, which in turn, was based upon Department of Commerce data; and, NEM data was obtained from Table B 20 in this report. Data for CE[R.sub.1] was obtained from the following three sources:

(a) 1956 60: Federal Reserve Bulletin, December 1961, p. 1495;

(b) 1961 66: Federal Reserve Bulletin, April 1967, p. 682;

(c) 1967 96: Federal report of the President, 1987, Table B 105.

Multiple linear simultaneous regression equations were computed using the two stage least squares technique:

CBI = [b.sub.0] + [b.sub.2]CE[R.sub.1] CFS = [b.sub.0] + [b.sub.1]CBI + [b.sub.2]NEM

The resulting t, F, and R squared statistics of these computations were initially examined. The model was first tested for multicollinearity by regressing the independent variables against each other (12,158).

The model was also evaluated for indications of possible heteroscedasticity using the Glejser and Modified Glejser tests (2,306 307), and for possible autocorrelation using the Durbin Watson test. After these econometric tests, the t, F, and R squared statistics were again examined.

EVALUATIVE DISCUSSION

It is possible that other variables are likely to be relevant for inclusion in the simultaneous model of this study, and would indicate directions of future studies. One critically important factor is the likely possibility that Japan and Germany will respond to the declining dollar with new trade and economic policies under pressure from American business partners and the U.S. Government. Japan has made some attempts to appease the American Congress, and thus stave off restrictive trade policies aimed primarily at Japan. The Japanese Government has had some modest "Buy American" campaigns and eased up on some tariffs but with little real impact on the trade problem. As the trade deficit with America grows Japan will be forced to reduce tariffs on imports or face a retaliatory tariff that will have widespread destabilizing impact upon their domestic economy. The Japanese will be reluctant to make major tariff concessions because of domestic political considerations. For example, the average Japanese family spends 50% of its annual budget on food, compared to 15% for the average American family, because of close political ties between the ruling party and domestic farmers. Outrageous tariffs on food commodities keep prices high by virtually destroying all foreign competition. The Japanese government will have to weigh the loss of domestic supporters against the growing trade problems with America and few governments favor foreign interests over domestic concerns. Only when America puts pressure on Japanese businesses, in the form of tariffs or import quotas, who sell to American markets to make concessions will the picture change significantly.

Unfilled orders is a key variable that should most likely be incorporated into a model, which includes changes in business inventories as an endogeneous variable because of the impact of, unfilled orders upon inventories and foreign sales. (9,16) Net exports should remain an exogeneous variable in most models attempting to evaluate the impact of the trade deficit. Other factors such as high levels of personal savings, and greater reliance upon other nations in trade are examples of complicating factors that could influence U.S. net exports. Such complications could make net exports an exceedingly difficult variable to estimate. Foreign exchange rates remain the best possible independent variables for estimating net exports despite complications in U.S. data related to the demand for U.S. currency.

One variable, which could possibly enhance the trade deficit model, are the levels of U.S. and foreign interest rates. While decreasing U.S. interest rates stimulate the economy, high interest rates provide incentive to foreign investors. A U.S. response to rising foreign interest rates has been to permit the value of the dollar to decline. A gradual shrinkage of the trade deficit is likely to keep an upward pressure on interest rates.

All of the above propositions assume economic stability. Future study should be conducted to determine the validity of this assumption. Such further research would be enhanced by the development of a similar model indication trends between exchange rates, final sales of goods, business inventories, and exports between the U.S. and other major trade partners including England, Canada, Mexico, Korea, Formosa, and Hong Kong. The investigators expect that there would be some important differences that would possibly suggest new problems in dealing with the trade problem. The Germany and Japanese economics may prove to be exceptions to the rule with respect to trade between America and other nations since the importance of the dollar as an international exchange unit may be less with respect to the yen and mark that with other currencies.

REFERENCES

Bailey, V. B. & Bowden, S. R. (1985). Department of Commerce, International Trade Administration. Understanding United States Foreign Data, Washington: Government Printing Office, August.

Bye, R. P. & Pinches, G. E. (1980). Additional evidence of heteroscedasticity in the market model, Journal of Financial and Quantitative Analysis, 15(2), June 1980.

Board of Governors of the Federal Reserve System, (1967). Federal Reserve Bulletin, Washington D.C.: Government Printing Office, April 1967, 682. Board of Governors of the Federal Reserve System, (1961). Federal Reserve Bulletin, Washington D.C.: Government Printing Office, December 1961, 1495.

Brennan, M. J. & Carroll, T. (1987). Preface to Quantitative Economics and Econometrics, Fourth Edition, Chicago: Southwestern Publishing Company.

Council of Economic Advisors. (1987). Economic Report of the President, Washington, D.C.: Government Printing Office.

Department of Commerce, (1974). Bureau of Economic Analysis. Long Term Economic Growth, 1860 1970, Washington D.C.: Government Printing Office.

Department of Commerce. (1985). Business Statistics: 1984, A Supplement to the Survey of Current Business, 24th Edition, Washington D.C.: Government Printing Office.

Duesenberry, J. S., From, G., Klein, L.R. & Kuh, E., (Eds.) (1965). The Brookings Quarterly Econometric Model of the United States, Chicago: Rand McNally and Company.

Larry R. Dale, Arkansas State University

Richard Williams, Georgetown University
Table 1: Econometric Results (Equation 1)

One Tailed T Test Significance: < 0.005

R Squared Statistic = 0.496

F Statistic = 8.21, Significance Level < 0.05

Multicollinearity:

CFS = 29.04 0.62 CER1, R Square = 0.018, VIF = 1.02

Autocorrelation: Durbin Watson Statistic = 2.33

 Significance
Heteroscedasticity: Levels

 CFS CER1

Glejser Test: 0.577 0.613
Modified Glejser Test: 0.297 0.267

Table 2 Econometric Results (Equation 2)

One Tailed T Test Significance: < 0.005 < 0.01

R Squared Statistic = 0.475

F Statistic = 7.53, Significance Level < 0.05

Multicollinearity:

NEM = 32.65 0.59 CBI, R Square = 0.051, VIF = 1.05

Autocorrelation: Durbin Watson Statistic = 2.02

 Significance
Heteroscedasticity: Levels

 CBI NEM

Glejser Test: 0.690 0.288
Modified Glejser Test: 0.601 0.413
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Author:Dale, Larry R.; Williams, Richard
Publication:Journal of International Business Research
Geographic Code:1USA
Date:Jan 1, 2003
Words:3748
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