U.S. international transactions in 1988.
The U.S. merchandise trade and current account deficit narrowed substantially in 1988, marking the first year of improvement in either balance since 1981. The improvement reflected continued rapid growth in merchandise exports, coupled with significant slowing of the growth of imports from the pace recorded in recent years. Net services, other than capital gains on direct investment assets abroad, were roughly the same in 1988 as in 1987.
Most of the improvement in the U.S. external balances occurred during the first two quarters of 1988. Both the trade and current account deficits narrowed only moderately in the third quarter, and they widened somewhat in the fourth quarter. In view of the unusually rapid pace of improvement in the first half of the year, some slowing of U.S. external adjustment in the second half should have been expected. That slowing probably also reflected the ebbing of the influence of the decline in the dollar through 1987, particularly after the dollar strengthened during 1988.
The net inflow of capital from abroad declined in 1988 as the current account deficit narrowed, and the composition of net capital flows shifted somewhat. Official net capital inflows declined noticeably, and foreigners sold U.S. corporate stocks on balance. Private foreign purchases of U.S. Treasury securities, however, rebounded from the net sales recorded in 1987, and private purchases of corporate bonds remained strong.
ECONOMIC INFLUENCES ON U.S.
Two factors that have influenced the developments in U.S. external balances that are depicted in chart U are the relative growth in income and demand at home and abroad and changes in the international price competitiveness of U.S. products.
Relative Growth Rates
During the years 1982-87, growth in U.S. gross national product and in domestic demand exceeded growth abroad, on average, and contributed importantly to the widening of the external deficit (chart 2). In 1988, however, relative growth probably had a net positive effect on the trade balance. Growth in output and domestic demand abroad, on average, exceeded that in the United States. While U.S. growth in 1988 was higher than the average growth over the previous five years, it did not match the rapid pace during 1987 (not shown in the chart); furthermore, demand in major foreign industrial countries, especially Japan and Germany, accelerated substantially. The growth of output in developing countries eased in 1988, but remained above its average level for the 1982-87 period.
The primary stimulus to U.S. net exports during 1988 came from the improvement in U.S. price competitiveness associated mostly with the depreciation of the dollar during the preceding three years but also with improvements in the performance of U.S. prices, wages, and productivity relative to those abroad. By the end of 1987, the price-adjusted, or real, exchange value of the dollar in terms of the currencies of the foreign Group of Ten countries had fallen more than 40 percent from its peak in early 1985, so that almost all of its rise during the first half of the 1980s was reversed (chart 3). On the basis of this measure, in which the currencies of the G-10 countries are weighted by their shares in world trade, the dollar strengthened somewhat during 1988, particularly around midyear, and it finished the year about 2 percent above its level at the end of 1987.
In terms of a more broadly based index of currencies weighted by shares in U.S. imports, by contrast, the dollar depreciated modestly on balance between the end of 1987 and the end of 1988 (table 1). The reason for the discrepancy is that most of the net appreciation for the year was against the currencies of major European countries, whose shares of world trade are relatively high but whose shares of U.S. imports are relatively low. Against the currencies of countries that weigh more heavily in U.S. imports, the dollar either showed little net change (the Japanese yen) or depreciated only moderately (the Canadian dollar, Mexican peso, and Korean won). The distinction between these measures of the dollar's exchange rate is important to the analysis of the elements of the U.S. external balance. The index weighted by import shares is more relevant to movements in import prices, whereas the index weighted by shares in world trade is more relevant to export volumes or to the global price competitiveness of U.S. goods.
The decline in the dollar since 1985 has contributed to a significant gain in U.S. international competitiveness in terms of labor costs in manufacturing. As indicated in chart 4, foreign unit labor costs in manufacturing, expressed in dollars, rose sharply relative to U.S. unit labor costs between 1985 and 1988. While the fall in the exchange value of the dollar accounted for most of this shift, increases in U.S. labor productivity relative to foreign productivity, and declines in U.S. wages relative to wages abroad, also helped. As a result of this improvement, U.S. unit labor costs in manufacturing were estimated to have been as much as 30 percent below the average level (in dollars) for other major industrial countries. Such estimates of the comparative levels of unit labor costs inevitably are crude, but they suggest that the adjustment of the U.S. external balance to the current level of exchange rates can continue for some time if output capacity is reallocated toward the United States to take advantage of relatively lower labor costs here.1 1. Evidence that relative rates of investment in manufacturing across countries have responded to international differences in labor costs is considered in Peter Hooper, "Exchange Rates and U.S. External Adjustment in the Short Run and the Long Run," International Finance Discussion Papers 346 (Board of Governors of the Federal Reserve System, March 1989).
DEVELOPMENT IN U.S. MERCHANDISE
The merchandise trade deficit narrowed more than $30 billion last year to $127 billion, marking the first year of improvement since 1980 (table 2). The value of exports rose 24 percent between the fourth quarter of 1987 and the fourth quarter of 1988, continuing the rapid expansion of the year before (table 3). Imports grew much more slowly, in sharp contrast to their strong growth in 1987. Most of the improvement in the deficit in 1988 came during the first half of the year, as exports grew at an extremely rapid rate and imports changed little. In the second half of the year, export growth slowed, while import growth picked up and actually exceeded the rate of expansion in exports in volume terms.
Growth in Exports
The expansion of the value of U.S. exports last year was spread across commodity categories. Two-thirds of the growth in the value of agricultural exports was due to increases in prices. Prices for major export crops (particularly wheat and soybeans) rose sharply in the wake of the severe drought in key sections of the country. The expansion in the value of nonagricultural exports, on the other hand, was largely real; the prices of these exports rose only moderately, about in line with the increase in domestic producer prices.
The volume of nonagricultural exports grew much faster than can be accounted for by growth abroad alone, so that much of the expansion of exports was probably a direct result of the improvement in the price competitiveness of U.S. products in foreign markets. However, the growth of exports (particularly of industrial supplies, capital goods, and automobiles) slowed substantially in the second half of the year (table 4). Nonagricultural exports expanded quite rapidly for 1988 as a whole and to most of the regions of the world (table 5). Exports to the newly industrializing economies of Asia (NIEs) were particularly strong, spurred both by rapid economic growth in those countries and by more recent gains in U.S. price competitiveness in those markets. Shipments to Canada, Western Europe, and Japan increased at a rapid pace during the first half of the year, and they slowed substantially in the second half.
Several factors may explain the shift in the growth of exports in the second half of 1988. One is timing: The slowdown represented a transitory pause following an unusual bunching of shipments in the first half of the year. The validity of this explanation cannot be assessed until more time has gone by. Nevertheless, in light of the phenomenal (and unexpected) growth of exports in the first half of the year, timing must have played some role.
A second possible explanation is the emergence of capacity constraints in U.S. manufacturing production, which is indicated by the relatively high and rising level of capacity utilization in a number of key U.S. industries. However, among industries that are important in U.S. exports and that are shown in table 6, only two, chemicals and paper, had reached record utilization rates at the end of 1988. Utilization rates for aircraft and certain nonferrous metals are also reported to have been relatively high. In most other industries, utilization rates were still somewhat below the peaks reached in 1978-80. Capacity constraints may have affected export growth in some areas, but they probably were not a major factor underlying the rapid deceleration of export growth after mid-1988. Had such constraints been binding, significant upward pressure on export prices would have emerged. Yet, overall nonagricultural export prices showed no signs of accelerating during the year.
A third possible explanation for the shift in export growth in mid-1988 is the erosion of the effects of the earlier decline in the dollar. However, the positive effects of gains in U.S. price competitiveness are unlikely to have disappeared so abruptly. Empirical models that relate changes in the trade balance to changes in exchange rates suggest that, although much of the adjustment comes within four to six quarters, the effects of a depreciation of the dollar are felt over two to three years. The predictions of a model that incorporates such adjustment lags suggest that the partial trade balance (that is, the trade balance excluding agricultural exports, oil imports, and both imports and exports of computers) adjusted more slowly than expected through 1987, and caught up to the model prediction by mid-1988 (see chart 5).2 The actual balance dropped more sharply than the model predicted in the second half of the year. If the historical relationship between exchange rates and the trade balance has remained the same, the pattern of export growth and external adjustment during 1988 cannot be explained solely by the wearing off of the effects of the depreciation of the dollar.
A final possible explanation is a slackening of economic growth abroad, particularly in Canada, Germany, Japan, and the United Kingdom, during the second half of 1988. While this slackening was evident in several major industrial countries, growth for all foreign countries (weighted by shares in U.S. exports) appears to have been about unchanged between the first and second halves of the year; thus growth abroad can account for little if any of the slowdown in export growth. 2. Imports and exports of computers have been excluded because their unusual behavior during the 1980s (discussed below) has made them particularly difficult to model. The model used to produce these predictions is quite similar to one that has been documented and discussed in William L. Helkie and Peter Hooper, "The U.S. External Deficit in the 1980s: An Empirical Analysis," in Ralph C. Bryant, Gerald Holtham, and Peter Hooper, eds., External Deficits and the Dollar: The Pit and the Pendulum (Brookings Institution, 1988), and Ellen E. Meade, "Exchange Rates, Adjustment, and the J-Curve," FEDERAL RESERVE BULLETIN, vol. 74 (October 1988), pp. 633-44.
Some additional evidence on the scope for further stimulus to exports from the past depreciation of the dollar can be found in movements in U.S. shares of world trade. With the real exchange value of the dollar against the other G-10 currencies now back almost to its level at the beginning of the decade, U.S. exports may reasonably be expected to begin regaining their share in world markets at that time.3 In the first half of 1988, the U.S. share in the total volume of exports from the United States, the European Community, and Japan to all countries was about midway between its level in 1980 and its low point in 1985 (chart 6). These data suggest that there is room for further gains in exports. However, overall export shares may be a misleading indicator of the effects of changes in price competitiveness, because they include U.S., Japanese, and EC exports to each other. It is not possible to distinguish between a decline in the overall U.S. export share due to reduced competitiveness of U.S. exports vis-a-vis Japanese and EC exports in foreign markets, and a decline in that share due to strong U.S. growth and demand for imports (from Japan, the European Community, and elsewhere). Examination of trade shares in third markets (that is, markets other than the United States, Japan, and the European Community) allows us to focus more directly on the effects of changes in the price competitiveness of U.S. exports against exports of the other two regions. In the first half of 1988, the United States regained the share of exports to third-country markets it had had in 1980. This measure suggests somewhat less scope for further adjustment at current exchange rates than is indicated by the overall shares.
In sum, the increase in U.S. price competitiveness associated with the decline in the dollar during 1985-87 had had substantial benefits for U.S. exports by mid-1988. Some slackening of export growth was to be expected thereafter, as the effects of that depreciation began to wear off. Capacity constraints also may have impinged on export growth by midyear in some sectors. In addition, much of the slowing of export growth after midyear probably reflected a bunching of deliveries in the first half of the year. 3. Of course, changes in other factors affecting U.S. trade flows since 1980 could prevent a restoration of the trade shares of that time. Nevertheless, several studies have suggested that the rise in the dollar between 1980 and early 1985 accounted for a large portion of the widening of the trade deficit. See, for example, Peter Hooper and Catherine L. Mann, The Emergence and Persistence of the U.S. External Deficit: 1980-87, Princeton Studies in International Finance, 1989.
Prices of Imports
Total import prices (as measured from the national income and product accounts fixed-weight price index) rose 3 percent during 1988, as a sharp drop in oil prices offset much of the rise in non-oil prices. The average price of imported oil fell 25 percent during 1988, to just under $13 per barrel in the fourth quarter. Overproduction by OPEC members, excess oil inventories, and continued disagreement about production quotas after the resolution of the Iran-Iraq war, depressed prices. The tensions among OPEC members were resolved, at least temporarily, toward the end of 1988, and both spot prices and import prices increased significantly early this year (chart 7).
Non-oil import prices appear to have responded sluggishly to the decline in the dollar since early 1985. However, different measures of import prices tell different stories about the amount of that adjustment. Chart 8 shows three measures of non-oil import prices: the implicit deflator from the national income and product accounts (NIPA), the fixed-weight price index published by the Bureau of Labor Statistics (BLS), and a NIPA price index that has been reconstructed with fixed weights. The fixed-weight price indexes hold the shares of the various products in the index constant at some base-period value. In contrast, the implicit deflator uses current-share weights, which are thus variable. The rise in the deflator since 1985 has been considerably smaller than those in the other two indexes. This difference arises because the former gives increasing weight over time to computers, and the price of computers has been falling rapidly (on a quality-adjusted basis). The BLS fixed-weight price index rose more than the fixed-weight NIPA index, partly because it uses a measure of computer prices that is not adjusted for quality and partly because it uses different measures of prices of raw and intermediate materials.
According to the fixed-weight NIPA price index, prices of non-oil imports rose in 1988 at about the same rate as they had on average over the previous two years (table 7). The most rapid increases were recorded for industrial supplies, particularly paper, chemicals, steel, and nonferrous metals (other than gold); the prices of other categories generally rose less than half as much. In most cases, prices increased more rapidly in the first half of the year than in the second half; the deceleration, particularly in the third quarter, may have reflected an unusually swift incorporation of the effects of the appreciation of the dollar at midyear.
The volume of oil imports rose fairly strongly in 1988, partly in response to the sharp decline in oil prices and partly in anticipation of future price increases. Domestic oil consumption rose 3 percent, while domestic oil production declined nearly 2 percent. The growth of non-oil imports slowed significantly, however, as increases in the prices of imports relative to the prices of domestically produced goods finally began to depress the demand for imports (table 8). Nevertheless, the continued robust growth in total domestic demand kept the quantity of non-oil imports growing for the year as a whole. With the exception of capital goods, most categories of imports declined in the first half of the year from the high levels that had been reached during an inventory build-up near the end of 1987. Strong domestic investment spending sustained the demand for imports of capital goods throughout the year. Imports of other goods, especially consumer goods and autos, rebounded during the second half of the year, partly in response to strength in domestic consumption. In addition, some of the pick-up in imports of consumer goods and autos late in the year may have reflected timing factors related to the Japanese voluntary-restraint agreement for autos and the impending removal of the Generalized System of Preferences privileges for certain Asian countries.
Trade in Computers
Since the early 1980s, both U.S. imports and U.S. exports of computers, computer accessories, peripherals, and related products have increased dramatically. Technological advances in the computer industry have been extremely rapid, so much so that the Commerce Department measures the domestic prices of these products with a quality-adjusted index. A quality-adjusted, or hedonic, price index for a product measures prices across time for a given basket of services derived from that product. When an industry is advancing as rapidly as computers have in the 1980s, unadjusted price indexes can overstate the true price change. Conventionally measured, prices of computers may well have risen during the 1980s. However, the services those computers provide have increased at a considerably faster rate, and the hedonic price index for computers has declined rapidly.
Unfortunately, quality-adjusted measures of prices for actual imports and exports of computers are not available. In their place the Commerce Department uses the quality-adjusted price for computers that is used to deflate the computer portion of domestic expenditures on producers' durable equipment.4 On this basis, computer prices at the end of 1988 were almost 70 percent lower than they were in 1982 (chart 9). This decline in prices resulted in a rapid increase in the measured volumes of exports and imports of computers, even though the value of these imports and exports rose only moderately faster than the value of other imports and exports. In real terms, the share of computer exports in nonagricultural exports rose from about 5 percent in 1982 to 21 percent last year; the share of computers in real imports has risen equally sharply (table 9). These developments have important implications for the analysis of movements in overall import and export volumes and price indexes (as noted above). Because both exports and imports of computers have grown rapidly in recent years, however, trade in computers did not contribute substantially to either the widening of the trade deficit through 1987 or the narrowing of the deficit last year. 4. See David W. Cartwright, "Improved Deflation of Purchases of Computers," Survey of Current Business, vol. 66 (March 1986), pp. 7-10; and Rosanne Cole and others, "Quality Adjusted Price Indexes for Computer Processors and Selected Peripheral Equipment," Survey of Current Business, vol. 66 (January 1986), pp. 41-50.
NONTRADE CURRENT ACCOUNT
In 1988, net services and transfers by the United States declined significantly and registered a small deficit for the first time in more than three decades (table 10). The decline was more than accounted for by a large swing from capital gains on U.S. direct investment abroad in 1987, when the dollar depreciated, to capital losses in 1988, when the dollar appreciated. These capital gains and losses result when the assets and liabilities of foreign affiliates of U.S. corporations, which are denominated in foreign currencies, are revalued in dollars at changed exchange rates.
Between 1980 and 1985, while the dollar was rising, capital losses reduced the current account (chart 10). Just the reverse occurred during 1985-87, when the dollar was falling. The effect that these changing currency-translation gains and losses have had on the current account has varied with changes in the currency composition of the assets and liabilities of foreign affiliates. Excluding capital gains and losses, net direct investment income rose significantly further last year, to well over $30 billion, reflecting the strong growth of economic activity abroad.
The net deficit on portfolio investment income, which has increased rapidly since 1985, rose to nearly $30 billion in 1988. Rapid growth in U.S. net portfolio liabilities to the rest of the world more than accounted for the increase. In fact, the decline in total net investment income flows (including portfolio and direct investment, exclusive of capital gains) has not nearly matched the growth in U.S. net foreign indebtedness. This discrepancy developed because the average rate of return on U.S. assets abroad exceeds by a significant margin the average rate of return that foreign residents earn on their holdings in the United States. The difference in rates of return reflects several factors. First, the stock of U.S. direct investment assets abroad is probably undervalued substantially relative to the flow of income that it produces, as discussed below. Second, a relatively large portion of U.S. portfolio liabilities to foreigners is in corporate stocks, for which a portion of income (capital gains) is not recorded in the international accounts. Third, a considerable portion of portfolio income is derived from the international activity of U.S. banks. The banks are intermediaries, which charge more on their loans to foreigners than they pay on their deposits and other liabilities to foreigners.
Other net service receipts increased fairly strongly last year, as tourism, travel, and transportation expenditures responded to earlier gains in U.S. price competitiveness.
CAPITAL ACCOUNT TRANSACTIONS
Both net official and net private capital inflows declined last year, reflecting the narrowing of the current account deficit (table 11). In 1987, the increase in foreign official holdings in the United States fell well short of the total increase in official holdings of dollar reserves by foreign authorities, a development that suggested that many of those dollar reserves were being invested outside the United States. In 1988, the increase in official holdings in the United States exceeded increases in dollar reserves reported by foreign authorities; this shift indicated that, in addition to dollar accumulation by some official monetary authorities, foreign official dollar reserves were being moved from the Eurodollar markets to the United States.
Among private capital flows, net bank-reported inflows were off sharply in 1988 from the 1987 pace, when the inflows had reflected in part the substantial deposits in Euromarkets by foreign central banks. Foreigners sold U.S. corporate stocks on balance in 1988, reversing the net purchases of the previous year. However, foreign private purchases of Treasury securities rebounded from a decline in 1987. Despite highly publicized increases in foreign acquisitions of U.S. firms, foreign direct investment in the United States in 1988 did not exceed the high level recorded in 1987. Although a U.S. petroleum company sold significant amounts of assets, the level of U.S. direct investment abroad was also little changed in 1988 after an adjustment to exclude currency-translation gains and losses.
U.S. INTERNATIONAL INVESTMENT
As a result of the continued net inflow of capital last year, the official U.S. net foreign investment position is estimated to have declined $120 billion, to a deficit of nearly $500 billion at the end of 1988 (table 12). This estimate does not take into account capital gains and losses on nondirect investment assets and liabilities during 1988, as the official data will do when they are released by the Department of Commerce in June. Recent studies have suggested that the recorded investment position is substantially understated.5 One reason for the understatement is that direct investment assets are recored at book value rather than at current market value. Crude attempts to revalue direct investment claims and liabilities at current market prices suggest that the recorded direct investment position was undervalued more than $300 billion at the end of 1987. This undervaluation helps to explain why U.S. net direct investment receipts (exclusive of currency-translation gains and losses) are still significantly positive.6 At the same time, the recorded investment position may be overstated because it does not take into account unrecorded capital inflows, and because the current market value of loans to some countries with debt problems is substantially below their book value. The U.S. international transaction accounts have shown large positive net errors and omissions cumulating to about $200 billion over the past three decades. To the extent that some of this cumulative statistical discrepancy in the accounts represented unrecorded net capital inflows, the net foreign investment position would be still more negative.
In brief, if adjustments were made for the valuation changes and statistical discrepancies just discussed, the U.S. net foreign investment position would be substantially higher, on balance, than the official figure. In any event, that position would be continuing to fall rapidly, reflecting the deficit in the current account. 5. See Robert Eisner and Paul J. Pieper, "The World's Greatest Debtor Nation?" paper presented at the meetings of the American Economic Association, December 1988; Lois Stekler, "Adequacy of International Transactions and Position Data for Policy Coordination," International Finance Discussion Papers 337 (Board of Governors of the Federal Reserve System, November 1988); Michael Ulan and William G. Dewald, "The U.S. Net International Investment Position: The Numbers Are Misstated and Misunderstood," U.S. Department of State, February 1989. 6. It has been suggested by many that the international investment position would be raised further if official gold holdings were valued at the current market price rather than at the official price of $42.22 per ounce. However, the valuation of gold holdings has no bearing on the U.S. net investment income flows.
PROSPECTS FOR 1989
While the nominal merchandise trade and current account deficits improved substantially in 1988, much of the improvement occurred in the first two quarters of the year. The slowdown in the rate of improvement during the second half of 1988 has mixed and uncertain implications for further adjustment in 1989. On the one hand, this slowdown may be a transitory pause, with more adjustment to come. The net decline in the value of the dollar since early 1985, coupled with the productivity gains and only moderate increases in U.S. wages and other costs, has substantially improved U.S. price and cost competitiveness. Further adjustment may take place as investors take advantage of lower production costs in the United States relative to other industrial countries. On the other hand, much of the adjustment in the external deficit as a result of the dollar's nominal depreciation may have occurred already. Rapid growth in export volume over the past two years has gone a long way toward restoring U.S. shares in the total trade of industrial countries to their previous highs. Increases in import prices have tended to depress the demand for imports, but the continued strength of domestic demand limits the scope for significant reduction in real imports from their current high levels. Strong domestic demand also puts upward pressure on U.S. prices and interest rates, which could further hinder external adjustment by reducing U.S. price competitiveness and by increasing interest payments on the growing U.S. net external debt position.
Table : 1. Change in the real exchange value of the dollar against selected currencies, 1985-88.
Table : 2. U. S. merchandise trade, 1985-1988
Table : 3. Changes in U.S. merchandise exports and imports, 1987-88
Table : 4. Changes in the volume of U.S. nonagriculturalexports, selected periods, 1981-88
Table : 5. U.S. nonagricultural exports, by region, 1987-88
Table : 6. U.S. merchandise exports and manufacturing capacity utilization, selected periods, 1987-88
Table : 7. Changes in the prices of U.S. imports, 1985-88
Table : 8. Growth in the volume of U.S. imports, 1986-88
Table : 9. Computers as a share of U.S. merchandise trade, selected years, 1980-88
Table : 10. U.S. nontrade current account transactions, 1984-88
Table : 11. U.S. capital account transactions, 1984-88
Table : 12. International investment position of the United States, 1984-88
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|Title Annotation:||merchandise trade and current account|
|Author:||Meade, Ellen E.|
|Publication:||Federal Reserve Bulletin|
|Date:||May 1, 1989|
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