Webcast 032 | Resurgent dollar is not good for business

The US Dollar has strengthened in March: Rebecca Harding discusses the consequences of a potential rise in US interest rates on emerging markets and the rise of the yuan as a major trade currency.

 

Webcast 032 Author  |  Rebecca Harding  |  CEO

Gold Standard

Three links that show the Yuan is ready to float  |  The value of the yuan against the US dollar is not making the headlines it should at the moment. Between the 17th and 20th March it appreciated by nearly 1%. Much of this volatility was arguably a response to the Federal Open Market Committee’s (FOMC’s) removal of the word “patient” from its statement on US interest rates. However, between the same dates, gold prices increased by nearly 3% prompting China to announce that the value of its currency against the US dollar was “appropriate”.

The occurrence of these three things within a week does not look like a coincidence, especially given that the Asian Infrastructure Investment Bank, first conceptualised in October 2013, acquired the support of the UK government, some European governments, the IMF and the Asia Development Bank during March 2015.

As China’s economy rebalances and becomes demand-led rather than export and infrastructure driven, it is in China’s interests to support trade in its neighbouring countries. This allows the region as a whole to develop by picking up some of the intermediate manufactured goods production that China can re-distribute through its own supply networks as it moves further up the manufacturing value chain.

Markets are markets and it is a mistake to conclude much from a few weeks of data. Yet it has shown how the re-focusing of China’s currency policy could have global market consequences. Currency policy is currently hidden within a multitude of different signals which appear to have converged during early March. China’s policy makers may be showing that they want to expose the yuan to international markets as they prepare for capital account convertibility. But they have also shown that they are preparing the yuan to establish itself in trade finance and indeed international markets as the second global currency.

There are three reasons for stating that the yuan is strengthening as a global currency: the first is trade, the second is the link between trade and the value of the yuan and the third is the link between gold and the value of the currency.

First, the link between trade and gold in China’s case is clear. Figure 1 shows how gold prices and China’s trade have moved together since June 2001 with a correlation of above 90%. The movements were almost identical up to the end of Q3 2013 when China’s trade starting slowing, de-coupled for 12 months to the start of Q4 2014 and have been similar for the last four months. February’s drop in gold prices mirrors China’s drop in trade and while this is clearly not causality, the closeness of the correlation is important.

 

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Figure 1  |  Monthly Value of Chinese Total Trade (USDbn) versus XAU-USD Gold Spot Price, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

Second, the correlation between Chinese trade and the value of the currency is similarly high at nearly 95%. However, interestingly, against the USDCNY spot (where strengthening of the yuan is shown by a downward trend) the correlation with Chinese trade is negative. In other words, despite a perception that the yuan’s value is artificial because of its 2% peg against the US dollar, the mild appreciation of the yuan since 2005 has not had a detrimental effect on trade (Figure 2). What this suggests is that the peg is helping to shore up the currency’s strength as trade develops rather than being managed to shore up trade.

 

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Figure 2  |  Monthly Value of China’s Total Trade versus USD-CNY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

Further evidence of this is shown in the third link: between the value of the yuan and China’s trade in gold. The correlation is nearly 80%: that is to say that as the exchange rate has moved, so gold trade has increased (Figure 3).

 

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Figure 3  |  China’s Gold Trade (USDm) versus USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg

 

Three things are immediately striking about Figure 3: first, gold trade only really started when the currency first appreciated against the US dollar; second, gold trade spiked when the initial 1% peg against the dollar was introduced in 2012; third, imports of gold started to increase sharply again from Q2 2013 as pressures for reform grew and the country prepared for its 18th CPC Central Committee Meeting in November 2013.

 

What all this suggests is that China’s currency policy is apparently a great deal more coordinated than it might appear at first. It is impossible to know exactly how much gold the country has and the values of trade in physical gold also underestimate total trade in gold which may come from barter or alternative forms (such as jewellery). However, alongside the increase in recorded trade in gold, China has been reducing its foreign currency reserves. This suggests that there is the potential for a large currency shift away from the dollar towards the yuan. The fact that gold reserves are increasing while foreign exchange reserves are falling suggests that policy makers are less concerned about weak Chinese growth and exports as they are about ensuring that, when the time is right, the yuan can enter a free-float against the dollar with impunity.

The links between trade, the yuan and gold all point in one direction: expect the gold price to increase, the yuan to strengthen and China’s exports to increase. China’s economy does not look like it is slowing – but it could just be setting a new Gold Standard.

A dose of its own medicine

Why India has a clear way of boosting its economy through exports  |  When Mr. Modi takes office on the 21st May, his first thoughts will almost certainly not turn to US pharmaceutical imports, but maybe they should. India has been plagued by a trade deficit since 2006 which is likely to grow in double digits this year and next. Alongside this, its terms of trade (the value of its exports in relation to the value of its imports) have deteriorated substantially and although its share of world trade increased to above 2.5% in 2013 and is forecast to reach 3% by 2015, this is as much because of increases in imports as it is about increases in exports. The Rupee’s value against the US Dollar has slipped by over a third in the three years since May 2011 when confidence in emerging markets generally and India in particular was so strong but if Mr. Modi is to address some of the broader challenges he faces, then it is the link between trade, real economy and key indicators such as the value of the Rupee that he needs to tackle first.

This will not be a simple job because, at the moment, the speculative element in Indian markets and the dominance of its trade by imports means that the correlation between the currency and exports is relatively weak at 0.50. The correlation is slightly stronger between its imports and the value of its currency at 0.53, as shown in Figure 1, which illustrates something unusual about the relationship: as the currency becomes weaker, imports drop.

 

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Figure 1  |  Indian imports (USDm value, June 2001-April 2015)
against Rupees per USD, Last Price Monthly, June 2001- April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

India imports predominantly crude oil, which, with an estimated value of USD 175bn in 2014, is nearly three times higher than the next largest import – gold. If the currency devalues, then exports should become more competitive and imports less competitive since they are more expensive. India has increased its imports of oil over the time since 2006 by over 350% against a backdrop of a depreciating currency making it inflation-prone.

But this relationship also demonstrates the fact that India’s currency is prone to speculation. The correlation is weak against commodity exports and this suggests that it is not so much measuring the economic development and growth of the Indian economy as it is measuring the capacity of the economy to soak up imports from overseas. The Indian stock market is a measure of the investment potential of the Indian economy and it too is more strongly correlated with imports (0.91) than it is with exports (0.90), as illustrated in Figure 2.

 

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Figure 2  |  Indian imports (USDm value, June 2001-April 2015) vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

While the difference in the correlation between the BSE and exports and imports is marginal, it points to the fact that investors are, arguably, measuring the success of the economy against their own capacity to invest in it. The post-dotcom hubris that surrounded India’s development in the early 2000’s spawned an excitement about India’s potential growth that fuelled inward investments in biotechnology, pharmaceuticals and electronics from developed world economies, particularly the United States. And yet, paradoxically perhaps, India’s trade itself has shifted markedly away from the developed world economies and towards economies in the Middle East and Asia.

 

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Figure 3  |  Moving focus – how India’s trade is shifting from Europe to Asia and the Middle East
Source  |  DeltaMetrics 2014

 

For example, China was India’s twelfth largest export destination in 2001 but is its third largest now and Singapore was its eleventh but fourth largest now. The UK was India’s fourth largest export destination but is now 7th and Germany its fifth, but is now 8th. India’s fastest growing export destinations are Indonesia, Vietnam and Brazil and while the UAE has risen from second to first, much of this is because of exports of diamonds, jewellery and gold.

Its import structure has changed as well, reflecting India’s insatiable demand for oil, diamonds, gold and jewellery. In 2001 the UAE was ranked 14th and Saudia Arabia are nexus pheromones any good 18th. They are now 2nd and 3rd respectively. China is the number one importer and with import values into India of USD 71.9bn anticipated in 2014, its imports are worth more than twice those from Switzerland and the United States which ranked first and second in 2001.

Trade is normally glacial in the pace at which it changes so these shifts in the structure of India’s trade partners are worth dwelling on. The pattern that is being reflected is a shift away from the developed world towards the emerging world and while this is, in itself, not a bad thing, it pushes India’s trade structure increasingly towards that of an emerging economy. Its trade is heavily concentrated in refined oil (nearly 19% of its exports) and pearls, precious stones, precious metals and jewellery (16%). Pharmaceuticals overall account for around 3% and while this is more than its concentration ratio of 2.5% in 2001, it is modest in comparison to its commodity exports.

Exports to the emerging economies are largely commodity-based: for example, exports to Vietnam are dominated by beef and soyabean cakes, maize and fish while exports to Brazil are oil, synthetic filament thread (used to stitch car seats), carbon and coke and insecticides. Yet to Germany, its top five export sectors include aircraft parts and cars, while to the US they include medicines.

It would be a mistake for policy makers to ignore the importance of traditional areas of export strength. Precious metal, pearl and jewellery exports to the UAE, for example are strongly correlated with the value of the currency at 0.61, as shown in Figure 4.

 

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Figure 4  |  Exports of pearls, precious stones, precious metals and jewellery (USDm) to the UAE,
June 2001-April 2015 against Rupees per USD, June 2001-April 2014, Last Price Monthly

Source  |  DeltaMetrics 2014, Bloomberg

 

It would also be misguided to ignore the importance of emerging markets in Asia. As Figure 5 shows, there is a very strong correlation (0.91) between the value of India’s Iron Ore exports to China and the Indian Stock Exchange.

 

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Figure 5  |  Indian exports of ores, slag and ash to China (USDm value, June 2001-April 2015)
vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg

 

Indian pharmaceutical exports to the United States, however, are almost as highly correlated with the BSE at 0.88 and this is important for policy makers. Over the period since 2001, the comparative advantage of Indian pharmaceuticals has gone from positive to negative and while the comparative disadvantage of Indian electronics exports (measured through revealed comparative advantage) has gone from -0.66 to -0.46, given the powerhouse that is India’s innovation economy, this should be reflected in its electronics exports as well. Yet the correlation between India’s trade and proxies for its innovation (the amount the government spends on R&D and business expenditure on R&D) are very high at over 0.93 as are skills, wages and foreign direct investment. More than this, the currency elasticity of trade is 0.99 correlated with trade.

All of this gives Mr. Modi’s team a clear lever to stimulate the economy. First, in the short term, the currency should be kept weak – this will have the effect of closing the trade deficit simply because the responsiveness of trade to changes in the currency is so high. This will promote exports in areas where price competitiveness is key, such as oil or iron ore, or even beef, which is a fast growing export product.

Second, India’s new government needs to think about its long term growth which will only come from extending education into rural communities, building on its high level skills base in cities and innovation – building on its successes in software and business services as well as in pharmaceuticals. South-South trade between emerging economies is commodity and infrastructure focuses and Delta Economics is not positive about its pace of growth in the immediate future. Accordingly, as the developed world begins to emerge from the financial crisis, India needs to take a dose of its own medicine to re-connect with these markets as they will help it to restore its competitive advantage in the innovative sectors that were so vibrant ten years ago.

Webcast 012 | Is Mexico the new China?

Rebecca Harding presents Carlos Sanchez Pavan and Shannon Manders to uncover the key trade drivers behind Mexico€™s strengthening supply chains. Mexico has been a strong beneficiary of re-shoring in manufacturing and the country’s strong economic and political structural changes have facilitated trade growth in automobiles, auto parts, oil and alternative energies. Delta Economics’ view is that Mexico and increasingly, the Latin American region, have growing competitive advantages over emerging markets in Asia and that China is becoming less competitive in wage and productivity terms, relative to Mexico.

 

Webcast 012 Author  |  Rebecca Harding  |  CEO

Asia Pacific

Most obvious declines in estimated and forecast trade are in China, Japan and Australia in Asia. Australia is highly dependent on China as an export partner, particularly for its iron ore and coal and, as China’s infrastructure construction boom slows and China’s economic growth also slows, Australia’s forecast export growth is also expected to fall. Japan’s export trade has failed to pick up despite the devaluation of the Yen against the US Dollar and this trend is likely to continue into 2014 with exports pretty much static compared to a mild growth in 2013.

Don’t Cry for Me…

Why trade mistakes are hampering Latin American growth | In the context of the current Ukrainian crisis, the decision by Venezuela’s President, Nicolas Maduro, to suspend diplomatic and economic relations with Panama has barely registered. Trade between Panama and Venezuela is relatively small, worth an estimated US$ 1.2bn in 2013. Crude oil, which is Venezuela’s main export with a value of over US$ 2.6bn is not within the top 30 trade sectors between the two countries and therefore, on the face of it, the impact on long term policies to stabilise the Venezuelan economy may be minimal. Trade is highly volatile between Venezuela and Panama and Venezuela is more reliant on its trade with Panama for imports than it is for exports, as Figure 1 shows.

 

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Figure 1 | Estimated exports from Venezuela to Panama and imports to Venezuela from Panama, 2001-2014

Source | DeltaMetrics 2014

(Trade data between Venezuela and Panama contain a large number of zeroes thus data must be seen as indicative)

 

Second, and as Figure 1 also shows, the decision to stop trade with Panama potentially hurts Panama more than it hurts Venezuela. Venezuela was Panama’s largest export partner in 2013, although the US will take over from Venezuela during 2014. This calculation is ill-advised on several counts. For example, Venezuela relies heavily on the US for its oil exports. It is the US’s third largest importer of crude oil; it’s exports to the US of crude oil are ten times higher than for the second largest export partner – Germany. With inflation running at, reportedly, above 50% and with the fiscal deficit running at 16% of GDP, the country needs stability more than anything. Any tension with Panama has the potential to spill over into relations with the US and thereby affect its oil exports. The parallels with Ukraine’s situation are not drawn idly: street protests leading to a new government and increasing tensions with the US pose a risk of sanctions and this would not help Venezuela’s quest for sustainable economic growth.

Second, Venezuela is not amongst Latin America’s top 30 trade partners, and yet it is highly dependent on the region for its trade. As Panama’s canal grows so too will its trade both with Latin America, North America, the Middle East and with Asia-Pacific. Its port-to-port trade with, say Singapore is forecast to grow by 10% in 2014 alone and with Hong Kong by 8%. Any greater political instability in Venezuela will have the effect of destabilising trade between other countries in the region. We are already forecasting substantial drops in the trade between it and many of the Latin American countries and yet it has the scope to act as a trade route through to North America if it keeps its export routes with Panama open.

 

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Figure 2 | Venezuela’s export trade with Latin American countries (2014 values and change on 2013) compared to Panama’s extra regional growth.

Source | DeltaMetrics 2014

 

The fact that its largest export product through Panama is automotives demonstrates how important this trade route is potentially in integrating Latin American and North American non-oil supply chains. Before the lock-down of trade we were expecting Venezuelan exports of cars to Panama to increase by over 18% this year, albeit from a small base.

Venezuela’s exports to Argentina are forecast to grow by over 9% during 2014 but Venezuela would do well to learn from Argentina’s trade track record, especially on restricting trade with other countries. Argentina imposed punitive tariffs on importers in 2011 requiring them to export from Argentina the amount in value terms that they were importing. The effect on trade for Argentina has been to increase export and import volatility since, as illustrated in Figure 3.

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Figure 3 | Argentinian exports and imports, June 2001-February 2014

Source | DeltaMetrics 2014

Since mid-2011 when the first range of additional tariffs were imposed, Argentina’s trade has experienced greater volatility in its trade and in fact, trade seems set on a downward trend. The seasonal swings in trade, which were already greater than pre-financial crisis appear to have been accentuated in the years since with a particularly severe drop in 2011-12 as the tariffs started to take effect.

While Venezuela has not introduced tariffs, it has just suspended its trade with Panama, the lessons from Argentina in terms of regional contagion cannot be understated. Figure 4 is the same chart, Argentinian exports and imports, against the value of the Brazilian Real and shows clearly that the value of the Real in relation to the USD has deteriorated over the same time period.

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Figure 4 | Risk of contagion: Argentina’s trade against the Real per USD exchange rate 2001-2014

Source | DeltaMetrics 2014, Bloomberg

It would be a mistake to say that Argentinian, or even Venezuelan trade directly causes a depreciation of the Real or other regional currencies. However, what Argentina’s economic and trade strategies have done, like other countries in the region, is make markets call into question the robustness and sustainability of economic performance and therefore to make them more bearish on the overall outlook as the collapse in the Peso and its knock-on effects to other Emerging Market currencies in January showed.

Venezuela’s trade is important to the region because of the link with the US and although they are not currently through Panama itself, the risk to that trade comes from geo-politics rather than trade economics. If it continues to suspend trade, then the US may impose restrictions on its imports. This could increase the downside risks to Venezuela’s trade forecast for 2014 and there is a clear risk for further contagion across the region. Perhaps like the Ukraine, this is a crisis that may start small but escalate to something bigger, particularly in economic terms. When it does, remember the lessons from Argentina, and don’t cry for me…..

Russia, Ukraine & Oil Prices

Why Crimea will be an economic flashpoint | Will the Crimean crisis have an enduring effect on oil prices? Europe teeters on the brink of a crisis that could, at best re-draw the post-Cold War borders between a Russian aligned Crimea and eastern Ukraine and a European aligned western Ukraine and, at worst, re-open the East-West fault-lines of the Cold War. Underlying the global geo-political tensions that are a consequence of the current stand-off is an equally pervasive and persistent tension between Russia and the Ukraine around oil and gas supply. Since 2006 Russia has interrupted its supply of oil and gas into the Ukraine in response to political and economic disputes (specifically non-payment by the Ukraine of its bills for gas supply). In January 2009 this caused a complete shut-down of oil and gas supplies by Russia to the Ukraine for thirteen days. Memories still linger and there will undoubtedly be nervousness in markets now as European energy security threatens to coincide with broader political instability.

It is easy to see why Russia is keen to retain its influence. Despite the fact that the country’s economy is bankrupt, it is the largest ex-Soviet destination of Russian oil and gas exports. Over 50% of its imports of oil and gas are from Russia and are worth over USD 6.7bn to Russia. Assuming other things are equal and that conflict is abated, growth rates in natural gas alone, are forecast to be higher than 16% in 2014 on their 2013 value.

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Figure 1 | Russian exports of Natural Gas to former Soviet States and forecast growth

Source DeltaMetrics 2014

Yet Ukraine supplies oil and gas in its own right, recently entering into agreements for shale gas exploration and production. Similarly, European countries, concerned about the impact of the 2009 crisis and their dependency on Russian supply through the Ukraine, have sought energy supplies directly from the Ukraine or from elsewhere. This reduces Russia’s influence on the Ukraine, even Europe, through gas supply in particular and it is arguably for this reason that Vladimir Putin will be keen to keep Ukraine within his control.

The effect on oil prices of all this is ambiguous and this is shown in Figure 2 which shows Ukrainian exports and imports of oil and gas against the oil spot price. Exports of oil and gas from the Ukraine track the oil price closely – price rises mean increases in exports and vice versa.

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Figure 2 | Ukraine’s Oil and Gas trade against the Oil Spot Last Price Monthly, June 2006-January 2014

Source DeltaMetrics 2014

 

Two things are clear from this chart.

First, there is a sharp increase in Ukrainian exports following the shutdown of Russia’s gas supplies in January 2009 that starts in May 2009. The increase is sharper than it was for Russia and continued until the beginning of the second quarter of 2011. Since then, Ukrainian exports have fallen: trade growth generally across all sectors has slowed following rapid catch up in 2010 from the financial crisis and oil and gas from these two countries were no exception. But equally, this drop for the Ukraine corresponds with the run up to and opening of the Nord Stream gas pipeline taking natural gas from Russia directly to Europe.

But second, since that point, trade has been relatively flat, indeed on a downward trend in both countries. Ukrainian exports have also been more volatile but until Q3 2012 moved in the same direction as oil prices. In other words, more was supplied as prices rose. Since then, oil prices and Ukrainian exports have periodically been inversely correlated with each other: that is, increases in price have been accompanied by lower exports from the Ukraine.

There is more to this than simply the breakdown of a relationship between two things in the wake of the financial crisis. Figure 3 shows Russian oil and gas exports to the Ukraine only from 2001 to 2014 against the NYSE Oil Spot Last Price Monthly over the same period.

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Figure 3 | Russian exports of Oil and Gas to the Ukraine versus NYSE Arca Oil Spot, Last Price Monthly, June 2001-January 2014

Source | DeltaMetrics 2014

The turning point is even clearer in Figure 3. From September 2011, Russian exports to the Ukraine appear to have moved inversely to the oil price as both Russia and the Ukraine began to use different supply routes and corridors to export their oil and gas. At the launch of the Nord Stream pipeline, around Ukraine, Vladimir Putin was clear about what this meant: “Any transit country has always the temptation to take advantage of its transit status,” he said. “That exclusivity is now disappearing.”

What does this suggest the outcome of the current crisis is likely to do to oil prices?

Much will depend on whether or not Russia gets its way and increases its influence in the Crimea and into the Ukraine quickly. If it does, then we can expect the risks to oil supply from the Ukraine itself and into the Ukraine from Russia to be short-lived meaning that oil prices will not be affected. However, Russia is unlikely to extend its influence into Western Ukraine without deepening instability and while it does not, we can expect Russia to restrict its supplies of oil and gas accordingly. This will put upwards pressure during 2014 on oil prices, not just because of the clear inverse relationship that appears to have developed but also because of the threat to energy security that it poses.

And in the very short term, March 2014 in particular, there is almost an inevitability about increased oil prices as markets absorb the likely effects of geo-political insecurity on energy prices and, hence, the prospects for economic recovery. How long this upward pressure persists depends on how quickly and effectively the crisis can be resolved.

Yen for a change?

Why devaluation of the Yen is unlikely to boost exportsShinzō Abe could not have been clearer in 2012: reversing the appreciation of the Yen since the start of the financial crisis in mid 2007 would stimulate export-led growth and assist a general objective of reflating the economy through higher import prices. Assuming a J-Curve effect, where the trade deficit would close after a short time-lag following a currency depreciation his view was that the policy would change Japan’s economic fortunes sustainably for the better.

Last week’s news that Japan’s trade deficit had widened was a confirmation that the J-Curve effect is not happening in Japan. In fact, the Yen has been depreciating against the US Dollar since October 2012, before Abenomics, and there is no sign in the Delta Economics forecast that there will be any pick-up in exports for the foreseeable future. Our forecast for Japan’s imports in 2014 has fallen slightly from 0.77% growth to 0.75% growth since September, but our forecast for export growth in 2014 has dropped from 0.14% growth in September last year to 0.01% growth now.

Some of this is because of the general failure of world trade to pick up pace in 2014. Japan is being particularly severely affected by this. Figure 1 shows Japan’s largest export partners and its forecast growth in 2014 with each.

 

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Figure 1 | Top ten largest export partners: forecast growth in exports 2014

Source | DeltaMetrics 2014

 

Trade with developed world partners is forecast largely to fall back this year with a particularly severe drop in trade with the US (-5.66%) and Germany (-1.31%). Even trade with its emerging economy partners in the Asia-Pacific region is not forecast to grow as quickly as we were forecasting in September 2013. For example, we were then forecasting that export trade with China would grow by 2.53% and we are now predicting somewhat slower growth at 2.42%.

The existence (or not) of a J-curve means that link between Japan’s trade and the value of the Yen per US Dollar exchange rate must be strong. Over the whole period, the correlation between the Yen in US Dollar terms and trade has been negative, at -0.48 which suggests both that imports may not always fall in line with expectations (rising when the currency depreciates) and that the relationship may not be strong enough for a J-curve effect. Figure 2 shows the trade ratio relative to the Yen-US Dollar exchange rate and demonstrates that the J-curve effect has not been working since April 2010.

 

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Figure 2 | Japan’s exports and imports against Yen-USD exchange rate, 2001-2014 (Yen per 1 USD)

Source | DeltaMetrics 2014, Bloomberg

 

Between June 2001 and January 2004 the Yen appreciated and exports declined relative to imports. A mild depreciation of the currency in Q1 2004 led to an increase in the ratio which continued until mid 2007 when the Yen started its more than five-year appreciation relative to the US Dollar. Exports fell relative to imports during this period. The rapid increase in trade in 2010 explains the sharp increase in the ratio from Q2 2010, despite sustained appreciation of the Yen, and was a consequence of catch-up after the global trade collapse in 2009.

 

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Figure 3 | Japan’s trade ratio (Exports divided by imports) against Yen USD exchange rate, 2001-2014 (Yen per USD)

Source | DeltaMetrics 2014, Bloomberg

However, what is really clear from Figure 2 is the sharp drop in the ratio after May 2011. This date is significant because it is 2 months after the Fukushima disaster. Exports relative to imports have not recovered since, despite mild depreciation of the currency from May 2011 and strong and sustained depreciation, arguably, since August 2011. In other words, the relationship between the Yen’s value and trade started to break down as early as 2010 when trade recovered from its global collapse.

The other striking observation from this chart is that the currency and trade are not especially correlated. There are few lags evident between a change in the currency’s value and a change in either exports or imports and over the period since the financial crisis, the correlation is relatively weak (-0.173) for imports and even weaker (-0.057) for exports. The negative correlation between imports and the Yen per US Dollar exchange rate points to a fact that as the Yen depreciates, imports will increase. Since 2011, this trend has become more obvious with the negative correlation strengthening to -0.606.

What might be behind this strengthening of the negative correlation with imports? Since Fukushima, Japan’s energy demand has been met increasingly by imports, particularly of Petroleum Gas, as illustrated in Figure 4. What this suggests is greater dependency on outside supply of energy and this is evidenced, not only in the increased imports of gas, coal and refined oil, but also in the fact that imports from Australia are forecast to grow by over 3% and from the Netherlands (which is a major oil and gas exporter) are forecast to grow by nearly 9% in 2014.

 

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Figure 4 | Largest exports and import products: forecast growth in trade 2014

Source | DeltaMetrics 2014

 

A steady increase in mineral fuel and iron and steel imports has been evident in the data since before the Fukishima disaster, however. Since the post-trade collapse recovery, it is imports of iron and steel, not energy, into Japan that have grown most strongly. Although demand for mineral fuels did rise after June 2011, the acceleration was not actually as fast as the previous two-year period from mid 2009, as illustrated in Figure 5. And, as the graph also shows, since December 2012, imports overall of mineral fuels have remained relatively static with a slight dip towards the end of 2013.

 

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Figure 5 | Top three import sectors relative to Yen-USD exchange rate, June 2001-Jan 2014

Source | DeltaMetrics 2014, Bloomberg

So is there any chance of export-led growth and a J-Curve effect? The decline in exports of Japanese cars of nearly 4% shown in Figure 4 is replicated at a sectoral level. Sector-level exports of vehicles, electronics and machinery, boilers and nuclear reactors seem impervious to changes in the exchange rate, as illustrated in Figure 6. Even during a period of strong currency appreciation exports rose and, since the depreciation in Q4 2012 exports have fallen.

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Figure 6 | Japan’s Top 3 export sectors against Yen per USD exchange rate, June 2001-January 2014

Source DeltaMetrics 2014, Bloomberg

 

Assumptions about the J-curve and its impact on trade rest on a belief that policy can over-ride the power of markets to influence the value of a currency. Since the financial crisis, currency markets have sought a reserve currency alongside the US dollar and, until October 2012, the effect was the appreciation of the Yen versus the dollar. Abenomics has been successful in convincing markets that it is on a course to reflate the Japanese economy and set it back on a path of export-led growth. Recent data on the deficit suggest that the policy has had little effect so far. The ability of Japanese policy makers to over-ride the market will only last as long as the market belief in the policy is sustained. Delta Economics forecasts suggest that this might not be for very long and that any further depreciation, however desirable, might be because of lack of faith in Japan rather than a direct consequence of policy.