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it August 25, 1978 Japan's"Real"Surplus True or false? Japaneseproducts have been inundating world markets, creating a trade surplus that has destabilized world financial relationships. The average headline reader would have no trouble answering that question. He's read how the Japanesetrade surplus has risen from $0.9 billion to $17.9 billion between the fourth quarter of 1975 and the fourth quarter of 1977. Still, the situation is not quite so clear cut. We are concerned here with changes in the physical volume of goods traded - the trade surplus. However, the trade-surplus figures given above are in nominal terms, measuring the value of exports and imports. Inflation and exchangerates It's well known that inflation and exchange-rate changes can drive a wedge between nominal and real trade balances, causing the former to increase far more than the latter. As a symptom of this, Japaneseexports, in dollar terms, increased 51 percent and imports 23 percent from 1975.4 to 1977.4. Yet in yen terms, Japaneseexports rose only 22 percent over this period, while imports were roughly constant. The differences between these sets of figures reflect the yen's appreciation, and suggest that much of the increased surplus could be due to the appreciation of the yen, rather than to a massive movement in trade volumes. This reflects what is called the curve'" phenomenon. Supposedly, when the yen appreciates, foreign exporters do not change the dollar price of their exports - which are Japan's imports - so that the yen prices of these goods fall. Similarly, Japaneseexporters do not change the yen prices of their goods, so that the dollar prices increase when the yen appreciates. These effects would imply a short-term rise in Japan's trade surplus, in both dollar and yen terms, even if no change occurred in the actual volumes of goods traded. Inflation differentials as well as exchange-rate changes can boost the size of Japan'ssurplus. If changes in exchange rates exactly matched the changes in inflation rates across countries, then the nominal surplus would give a rough indication of the size of the real surplus. In that situation, the value of Japaneseexports and imports would both rise at about the same rate as the physical volume of trade. But on the other hand, if the appreciation of a currency was greater than the country's inflation differential with other countries - exactly the case recently with the yen - then the nominal or value surplus would increase much faster than the real or volume surplus. To see this, suppose that Japanese export prices (in yen) had risen as fast as the Japanese wholesale-price index over this period (5 percent), and that Japanese import prices (in dollars) had risen as fast as the WPI (11 percent). Also, allow for a 23-percent appreciation of the yen with respect to the dollar. Then if Japan's trade volumes had been held constant at their 1975.4 levels, the nominal surplus would still have jumped to $12.5 billion in 1977.4 - solely because of inflation and exchange rate factors. Thus, trade volumes which meant rough balance at 1975.4 prices and exchange rates would imply quite sizeable u.s. (continued on page 2) Ia@'1 IT1 m(G)Jl .§@,1IT1 JFif CC li Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Franciscor nor of the Board of Governors of the Federal Reserve System. surpluses when evaluated at 1977.4 prices and exchange rates. In this light, the increase in the surplus may not indicate a flooding of world markets with japanese goods, but rather the initial effects of the sharp appreciation on the yen. Different deflators-and results \tVhat then is the true picture of japanese trade conditions? How have real trade flows changed over this recent period of spiraling increases in japan's nominal surplus? The most natural way to answer this question is to look at changes in japan's export and import price indices, and use these to deflate nominal exports and imports. Over the 1975.4-1977.4 period, japan's export and import price indices fell 7.6 and 9.0 percent respectively. Deflating yen trade changes by these indicates a 33 percent increase in real and a 10 percent increase in real imports, numbers which support the hypothesis. By this measure, the real trade surplus would have been $14.8 billion in 1977.4, almost equal to the nominal trade surplus of $17.9 billion in 1977.4. While the import price and volume numbers look reasonable, the export figures do not. There are a number of problems. First, the 7.6-percent fall in export prices, in a period when japanese wholesale prices were rising 7.5 percent, indicates that the foreign price for Japanese goods fell some 15 percent relative to the domestic price of these goods, yet japanese firms apparently responded to this decline in relative price with a 33-percent vol- 2 ume increase! On the dollar side, this indicates that the price of japanese goods abroad increased about 3 percent faster than non-japanese Yet, Japan enjoyed a 33percent increase in exports, which is very large given the relatively slow growth in world income. Where did all the demand for these goods come from? What's more, we get a different picture when we look at volume growth for seven major export goods, comprising almost half of total export value. Admittedly, there was a 52-percent increase in the number of motor-vehicles exported, along with 26 percent and 23 percent increases, respectiveIy, in the number of TV and radio receivers exported. In contrast, there were only moderate increases in exports of iron-and-steel products and synthetic fabrics, while the volume of chemical dropped 18 percent and ship exports (in tons) slumped 42 percent. One might argue that the sharp decline in Japanese ship exports is atypical of the overall export industry - especially in view of the world-wide glut of supertankers, of which Japan is the major producer. But conversely, we could argue that the sharp increase in auto exports is also atypical, since it represents in part the impact of soaring oil prices on the demand for the highmileage cars in which Japan specializes. But the point remains: export categories accounting for almost half of total exports showed much smaller volume growth than was indicated by the use of the export-price deflator. The aver-:- Physical Export Volume Chemical Fertilizers _ _ _ _ Iron and Steel Products • _ _ _ . _ TV Receivers Radio Receivers Ships age growth of real exports in these major categories was no more than 8 to 13 percent, depending on the weights chosen. This implies that volume growth in all other export commodities would have to average some 49-55 percent in order for total export volume to have risen 33 percent, as is suggested by the export price index. On balance, therefore, the Japanese export price index gives a real export picture which appears inconsistent with other data. Suppose then that we used other price measures to deflate exports and imports. Using the Japanese WPI to deflate Japanese exports (in yen) and using the U.s. WPI and the yen/dollar exchange rate to deflate Japaneseimports (in yen), implies an increase in exports of 16 -percent and in imports of 11 percent. The import figure is consistent with that given by the import price index, but the export figure shows much more moderate growth than is implied by export prices. In this case, the Japanesereal trade surplus in 1977.4 would have been a relatively modest $4.0 billion, versus the nominal trade surplus of $17.9 billion. J'Aode§tlI'n§ein export§? In sum, we have two quite different interpretations of what has happened to real Japaneseexports and, therefore, the real trade balance. In one, which is consistent with Japanese export prices, we have a sizeable increase in real exports and a real trade surplus that is only moderately smaller than the nominal surplus. If this is the case, Japan has lowered its export 3 Motor Vehicles prices roughly in line with the appreciation of the yen, and maintained and even expanded its share in foreign markets. In other words, Japan in this interpretation has acted as a small open economy whose export prices as well as import prices are determined in the world markets rather than in the Japanese market. In this circumstance, the well known J-curve phenomenon would not occur. There would be no rise in the relative dollar price of Japanese exports as the yen appreciated, because of the steady decline in the yen price of exports. The only market force in this context operating to reduce export growth would be the decline in profits from exporting, which would induce these industries to sell more at home than abroad. Under the other interpretation, which is more consistent with available volume figures, recent world income trends, and relative inflation rates, we get a much more modest increase in real exports, with most of the increase concentrated in 1976, before the major appreciation in the value of the yen. Most of the increase in Japan's nominal surplus would be due to distortions of the J-curve phenomenon, caused by the appreciation of the yen. Although we would normally expect the export-price deflator tQ give an accurate portrayal of real export behavior, the evidence suggests that Japan's export growth has been less robust than that measure indicates. And finally, given the sharp appreciation of the yen throughout 1978, the most recent data suggest that the real trade surplus has been clearly overstated this year if not before. Mkhael 8azdarich and Michael Keran u018u!4SEM"4Eln .. uo8a.lOe EpEAaNe o4EPI !!EMEH " E!U.loJ!IE:) • EUOZ!.1V.. e>lselV dJ ((j) 'llll?J 'OJSPUl?J:I ues (;S'L'ON GI Vd 319V1 S0d 'S'(1 llVW SSVlJ :JJ, BANKINGOATA- TWlElfTHflEDERAlRESERVE DISTRICT (Dollaramountsin millions) Selected Assets and Liabilities Large Commercial Banks Loans(gross,adjusted)and investments* Loans(gross,adjusted)- total Securityloans Commercialand industrial Realestate Consumerinstalment U.s. Treasurysecurities Other securities Deposits(lesscashitems)- total* Demanddeposits(adjusted) U.s. Governmentdeposits Timedeposits- total* Statesand politicalsubdivisions Savingsdeposits Other time deposits+ LargenegotiableCD's Weekly Averages of Daily Figures Amount Outstanding 8/9/78 115,462 93,372 2,376 27,658 31,882 16,788 8,065 14,025 110,633 30,900 216 77,805 6,653 31,516 36,906 17,371 Week ended 8/9178 Change from 812178 + + + - + + - + + + - + + - + - Changefrom yearago Dollars Percent 809 817 538 217 214 63 68 60 245 527 91 7 1 13 43 44 + 14,327 + 15,302 - 543 + 4,053 + 6,717 + 3,654 - + + - + + - + - 18.60 + 17.17 + 26.69 + 27.82 773 202 12,918 2,746 119 10,335 1,378 351 8,540 6,569 + Week ended 812178 + 14.17 + 19.60 - + + - + + - 8.75 1.42 13.22 9.75 35.52 15.32 26.12 1.10 30.11 60.81 + + Comparable year-agoperiod Member BanI<Reserve Position ExcessReserves( + )/Deficiency(-) Borrowings Net free(+)/Net borrowed (-) 41 15 56 + 75 82 7 + 1,381 + 366 Federal Funds-Seven large Banks InterbankFederalfund transactions Net purchases (+)/Net sales(-) Transactions with U.s. securitydealers Net loans(+)/Net borrowings(-) + 231 + 346 *Includesitemsnot shownseparately.:j:lndividuals, partnerships and corporations. + 28 172 144 + 526 + 400 Editorial comments may be addressed to the editor (William Burke) or to the author . . . . 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