Equilibrating mechanisms at work

In theory, a declining dollar should help the U.S. balance of trade by making imports relatively more expensive to Americans and exports relatively inexpensive to foreigners. However, the current macroeconomic imbalances cause this equilibrating mechanism to carriy some risks. Among the many fears about the current dollar depreciation are:

1) U.S. demand for imports is so inelastic that price increases won’t have much of an effect; 2) A sizeable chunk of the U.S. deficit is bilateral trade with China, and the dollar’s fall has not affected that exchange rate too much; 3) East Asian central banks will only tolerate so much of a fall before they decide to liquidate their dollar reserves, which would trigger a financial panic/run on the dollar/cats and dogs living together/mass hysteria (see Brad Setser for more on this — as well as the Economist)

Given all of this, it is nice to read about these equilibrating effects at work. Which leads me to today’s front-pager in the Wall Street Journal by Emily Nelson and Brooks Barnes:

As the dollar has fallen to a 12-year-low against the British pound and an all-time low against the five-year-old euro, Europeans now view the U.S. as one giant half-off sale on everything from clothes to coffee to restaurant meals. Because so many businesses now operate globally, comparison shopping is easy. At the London outpost of Nobu, the New York Japanese restaurant, a special set meal costs between $136 and $233 per person, at Friday’s exchange rate of $1.94 to the pound. A la carte, the monkfish paté with caviar costs $24.29, and the baby spinach with whitefish salad $22.35. All of which is out of the question for Catherine Watson, a 38-year-old photographer from Cardiff, Wales — except when she can snap up cheap dollars to pay for the same meal at Nobu in Manhattan. There, one night recently, armed with dollars purchased at about $1.89 to the pound, she and a friend started with the monkfish pate for $17 and the spinach salad for $16. The chef’s special dinners in New York are $80, $100 and $120, about 40% off London prices. “Things seem so cheap that you turn into a bit of the child in a candy store,” says Ms. Watson…. The hordes from the Old World streaming across the Atlantic are likely only to increase as the dollar, down about 10% against the pound and down 12% against the euro since April, is expected to fall further in 2005. Basic goods, such as household supplies, clothing and food have long tended to be less costly in the U.S., where sales and big discount chains are more prevalent than in Europe. But the disparity currently is much greater. And businesses, from airlines to hotel chains, are stepping up promotional efforts to portray the U.S. as a shopper’s paradise. Travel from some European countries to the U.S. is up nearly 25% so far this year, says Gabriella Vecchio, international marketing manager at the Travel Industry Association of America. That pace well exceeds the forecast that the U.S. Department of Commerce office of travel and tourism industries made last April for 9.3 million Europeans to visit the U.S. this year, a 7% increase from 2003. American Airlines says its trans-Atlantic flights are 81.3% full, up 3.9 points from a year ago, and it has added flights as well. In London subway advertising, the airline’s slogan is: “America Reduced.” “A weak dollar means bargain holidays,” declared a recent article in London’s Sunday Times. Other travel sections of British newspapers are filled with stories detailing how Christmas shopping in Manhattan promises savings even after hotel and airfare costs.

One can question whether the magnitude of these kind of flows will put a larger dent in the current account deficit. However, there is an intriguing question that this kind of story raises. As previously discussed, American productivity in nontradable sectors such as retail is considerably higher than other parts of the globe, which is one source of lower prices. If transport costs continue to decline, it would be interesting to speculate whether these sectors become an important comparative advantage for the United States on trade matters. Just a thought.