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Winter 1996 - Volume 1, No. 3

The Dollar and Tennessee's Trade
by Steven G. Livingston

Price competitiveness is essential to sales. This, surely, is the first lesson of business. And this holds true whether the market is in Tennessee in or in a foreign country. But in selling internationally, one doesn't always have full control over the price. There is an extra determinant of the price of one's goods: the value of the dollar. As the dollar rises against another currency, American products will cost more in that country (unless the exporter or the local retailer are willing to compensate by lowering their prices). Foreign exchange rates are thus an important part of global business.

The price of the dollar is an important part of the overall competitiveness of American firms internationally. Economists and government officials, as well as people in business, worry about the links between the dollar and America's ability to export. Some countries try, in effect, to "cheat" by maintaining artificially low exchange rates with the dollar (i.e. an expensive dollar), insuring that U.S. firms are always at a price disadvantage. Indeed, anything which raises the value of the dollar may hurt U.S. trade. One continuing problem with the U.S. budget deficit, for example, is concern that heavy U.S. government borrowing might produce higher U.S. interest rates than would otherwise be the case. This would lead to a stronger dollar, and contribute to the trade deficit.

In the first issue of Global Commerce we saw that the sudden devaluation of the Mexican peso quickly braked the expansion to Tennessee exports to that market. A second devaluation confirms the linkage of trade to the dollar. In late 1993, China devalued its yuan. Unlike Mexico, this was a carefully controlled one time action. We see in Chart 1 that this devaluation produced a slump in the growth rate of Tennessee

exports to China (the state's exports to China fluctuate greatly, so we have displayed a line showing the moving average of exports to better observe what happened). Again unlike Mexico, exports seem to have adjusted to the new exchange rate and continued on their merry way after this brief setback. However, a close look at either export line should convince you that the slope of the lines shifted downward. In other words, the rate of expansion of Tennessee exports may have been permanently slowed as a result of the Chinese action.

A third, happier story shows the effects of a weakening dollar. Much has been made of the soaring Japanese yen, which recently broke through the yen/dollar ratio of 100. This should be good news for exporters to Japan. And Tennessee products have in fact done very well there recently, as Chart 2 shows.

A Tennessee Trade-Weighted Dollar Index

These three country profiles are suggestive. But is there a way to get one single snap-shot of the entire global currency situation facing Tennessee exporters? Many U.S. and international agencies publish a monthly overall foreign exchange value of the dollar. For business, this can be somewhat misleading, because traders are concerned with exchange rates where they trade and not with an abstract world average. An effort to to create a more useful exchange rate figure is the trade-weighted dollar index. Here currencies are weighted according to the percentage of U.S. exports their countries take. Thus the index measures how the dollar is doing relative to our biggest trading partners.

Tennesseans may find a limitation with the several trade-weighted dollar averages which exist: they measure overall U.S. trade, not specifically Tennessee trade. Our export profile does not match that of the entire country. Chart 3 shows the

relative size of export markets for the state vs. the nation, based on 1991-1994 exports. As you can see, Canada is a much more important market for Tennessee than for the rest of the country. Japan and Mexico absorb a smaller percentage of Tennessee goods than is the national average. We have created a Tennessee trade-weighted dollar index based on our state's export profile. It factors in the currency rates of our 22 largest trading partners, who together account for about 90% of the state's exports. This index (with January 1993 set at 100) should be the most reliable guide to the currency situation affecting Tennessee exports. Chart 4 graphs the Tennessee index against the U.S. index. They do not move together. In particular, over the last several months the Tennessee index has been rising, indicating a tougher currency

environment for Tennessee traders, while the U.S. index has been falling, indicating a more favorable dollar rate for U.S. exporters generally. It should be noted that there is another reason for this discrepancy: the U.S. index does not include developing countries except for those in East Asia. Mexico, for example, is not included. Thus, while the falling dollar has been much commented upon recently, that dollar is only falling in the industrial world, it is doing very well indeed in most emerging markets.

The Impact of the Dollar on Tennessee Exports

The state's exports have grown robustly over the last several years, whether the dollar has risen or fallen. But, overall, have exchange rates operated to help or hinder this trend? Many firms attempt to shield themselves from foreign exchange risks. Some find ways of maintaining flexible pricing, some engage in sophisticated financial hedging operations, and many try to do business entirely in American dollars. So we cannot conclude that the value of dollar must always affect sales. But a final graph gives some indication that the dollar has its say in the success of Tennessee exports. Chart 5 measures the impact of the dollar on the last three years of Tennessee exports. It graphs the inverse of the Tennessee trade-weighted dollar index against the Tennessee export index, after some statistical adjustment. Because we presume that currency changes will usually take some time to affect trade, the dollar index is used as a leading indicator, it is lagged six months. January's dollar index is matched against June's export index, and so on. The Chart shows a remarkable ability of the dollar index to predict future changes in Tennessee exports. Six of the seven turning points in the export index are predicted five to seven months in advance by the dollar index. The exception is a big increase in exports, mostly to Germany and the U.K., in the first part of 1994 - this the index missed entirely.

In future issues, Global Commerce will be keeping a close watch on this graph to see if it continues to operate as an accurate leading indicator of the Tennessee trade picture. And we will follow the Tennessee trade-weighted dollar index, our single best measure of one of the most important influences on Tennessee's trade.

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