The Auto Deficit: Stuck In Neutral

A weaker dollar isn't an instant fix for U.S. carmakers' trade woes

Given the number of Japanese car plants that have opened in the U.S. in recent years, it may come as a surprise that the auto industry still accounts for nearly one-quarter of America's trade deficit. But it's true: Last year the U.S. imported $128 billion more in vehicles and auto parts than it sent abroad -- double the level of six years earlier. The trade deficit in autos was nearly as big as the one in oil. The Big Three say the dollar's strength, particularly vs. the yen, has given foreign rivals an unfair advantage.

So will the falling dollar shrink the trade deficit by giving U.S.-made vehicles an edge? With the dollar down 24% against the yen since early 2002, Detroit is a natural place to look for an improvement in the trade balance, because the auto sector is so huge. Domestic carmakers also have the capacity to step up production to replace imports and increase exports. In consumer goods, by contrast, the weaker dollar won't shrink the deficit much because domestic production capacity has withered away. A narrowing of the auto trade deficit would go a long way toward correcting the huge overall imbalance between what Americans consume and what they produce.

The outlook, though, is mixed. A weaker dollar will help shrink the auto trade deficit all right, but it's no instant cure. The trade gap in autos is a consequence of how the world's auto makers have constructed their global supply chains -- and they aren't about to reconfigure them just because the dollar is down. Unless the shift is large and lasting, they're more likely to respond tactically. Foreign auto makers will try to hold the line on prices to maintain U.S. market share, analysts say. Even if they are forced to raise prices on exports to the U.S., Detroit may not seize the chance to regain lost market share. More likely, analysts say, U.S. auto makers would raise their own prices in tandem with import prices to restore badly eroded profit margins. Says Sean P. McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Mich.: "In this business, normal economic rules of the universe don't apply."

In the short term, a weaker dollar could even widen the deficit. Why? Because Americans won't immediately switch to cheaper domestic alternatives. They'll buy nearly the same number of foreign-made autos but pay more for each one, increasing the import bill. That's the infamous effect that economists call the "J Curve."

America's last experience with a cheap dollar shows how persistent the auto trade gap is. The dollar fell 40% against the yen in the first half of the 1990s, yet the auto trade deficit with Japan shrank by just 20% -- and rebounded as the dollar strengthened. Likewise, the trade deficit with Germany is up 8% so far this year, even though the dollar has fallen 35% over the past three years against Germany's currency, the euro.


Part of the problem is that the global flow of autos and parts can't be changed quickly. True, the Japanese are adding capacity in the U.S., which will trim some of the deficit. But parts production, which accounts for 20% of the deficit, can't be moved so fast. "Carmakers are unlikely to...switch in mid-model life to U.S. parts" even with a cheaper dollar, says Keith Head, an economist and industry specialist at the University of British Columbia's Sauder School of Business. They'll be even less likely to switch if they aren't sure the dollar's weakness will last.

Keep in mind, too, that the dollar isn't falling against all currencies. It has risen against the Mexican peso. Both U.S. auto makers and Japanese transplants are sourcing more parts from Mexico. The result: The U.S. auto trade deficit with Mexico soared to $27 billion last year -- second only to the $44 billion deficit with Japan. That's one more reason currency moves won't quickly change the outlook for auto trade. It may give U.S. carmakers some much-needed breathing room. But wipe out the auto trade deficit? Probably not.

By Peter Coy in New York

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