Why The Soaring Yen Hasn't Narrowed The U.S. Trade Deficit

These days, amid all the good economic news on low inflation and surging gross-domestic-product growth, America's worsening trade deficit with Japan sticks out like a sore thumb. And trade relations between the world's two largest economies aren't getting any better with the breakdown of talks between the Clinton Administration and Hosokawa government. Even if the two warring titans find room for compromise, the gap is unlikely to improve anytime soon, according to a recent analysis by economists at Chemical Bank Corp. The reason: Japan's trade surplus with the U.S. is rooted in Japan's languishing economy and not barriers to "such cutting-edge U.S. exports as commercial jet aircraft and pharmaceuticals." At the same time that recession-battered Japanese consumers and businesses are buying fewer imported goods from the U.S., a resurgent U.S. economy is pulling in ever more imports from Japan.

Japan's weak economy also helps explain a puzzle that has been troubling economists over the past year at least: Why hasn't the surging yen reduced the trade deficit? Typically, a strengthening currency in the nation running a trade surplus is supposed to ameliorate trade deficits by making the surplus country's exports more expensive. But that just hasn't happened with the U.S. and Japan (chart). Since 1990, the merchandise trade balance with Japan has gone from -$41.1 billion to -$59.3 billion in 1993 at the same time that the yen went from 150 to 104 to the dollar. And this experience sharply contrasts with Europe in the 1980s. Then, a falling U.S. dollar engineered by the Reagan Administration in late 1985 turned a deep bilateral U.S. deficit into an impressive surplus.

The Chemical economists maintain that in the 1980s, a dollar devaluation was coupled with a capital-spending boom in Europe. Since capital goods are America's strongest export suit, the one-two punch was effective in eliminating the trade deficit with Europe. But in Japan, capital spending has been plunging along with that country's economy. The implication is clear: The fastest way to reduce the trade deficit is to get Japan's economy growing again.