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.When the dollar is strong, imports go up and exports go down, and the2.Manufacturing GDP in 2000 was $1,567 billion.Reducing the goods trade deficit by$200 billion to $226 billion represents 12.8 percent of manufacturing GDP.Manufacturingemployment in April 2002 was 16.8 million, and increasing this by 12.8 percent would add2.14 million additional manufacturing jobs.THE OVERVALUED DOLLAR AND THE U.S.SLUMP 147Copyright 2003 Institute for International Economics | http://www.iie.com Figure 7.1 Real broad dollar index and import/export ratio,1980-2001Source: Economic Report of the President, February 2002; and author s calculations.ratio therefore rises.The figure shows a clear robust positive relation thatis supported by the following regression:D(GM/GX) 1.91 1.07D(broad exchange rate);adjusted R2 0.41; Durbin-Watson 2.16where D(GM/GX) is the change in the ratio of goods imports to goodsexports, and D(broad exchange rate) is the change in the lagged broadexchange rate.The regression indicates that a one-point increase in thebroad exchange rate results in a 1.07 point increase in the import-exportratio (with a t-ratio of 3.7).Furthermore, the impact of exchange rate movements has become largerover the past two decades because the US economy has become moreengaged in trade.This is shown in figure 7.2, which shows exports andimports as a share of GDP.In 1980 exports and imports were 18.3 percentof GDP, but by 2001 they were 23.8 percent of GDP.Even more dramaticis the change in manufacturing openness, defined as manufacturingexports and imports as a share of manufacturing GDP.This is shown infigure 7.3.3 In 1980 manufacturing exports and imports were 60 percent3.Manufacturing exports are measured as goods exports minus agricultural exports.Manu-facturing imports are measured as goods imports minus petroleum and petroleum-basedproducts.148 DOLLAR OVERVALUATION AND THE WORLD ECONOMYCopyright 2003 Institute for International Economics | http://www.iie.com Figure 7.2 Exports plus imports as a percentage of GDP,1980-2001Source: Economic Report of the President, February 2002, updated by Economic Indicatorspublished by the Joint Economic Committee, April 2002.Figure 7.3 Manufacturing exports plus imports as a percentage ofmanufacturing GDP, 1980-2000Source: Economic Report of the President, February 2002, and author s calculations asdescribed in footnote 3.THE OVERVALUED DOLLAR AND THE U.S.SLUMP 149Copyright 2003 Institute for International Economics | http://www.iie.com Figure 7.4 Real broad dollar index and manufacturing profit shareSource: Economic Report of the President, February 2002, and author s calculations.of manufacturing GDP, but by 2000 they had risen to 116 percent ofmanufacturing GDP.The value of manufacturing trade (exports plusimports) now exceeds the total value of manufacturing output.Manufac-turing exports are 46 percent of manufacturing output, and manufacturingimports are 70 percent of manufacturing output.Given this exposure,overvaluation of the dollar whipsaws the manufacturing sector.A second indirect damage channel is investment spending, which isnegatively affected for two reasons.First, by reducing exports and domesticsales, an overvalued dollar contributes to excess capacity, which diminishesthe need to invest.Second, by making foreign goods cheaper, an overvalueddollar lowers profitability and reduces firms ability to finance investment.In August 2002, manufacturing capacity utilization was 74.6 percent, 6.3percentage points below the average for the period 1967-2001, and manufac-turing capacity utilization in 2002 is running at its lowest level since 1983.Figure 7.4 shows the Federal Reserve s broad currency index and the manu-facturing profit share, and it reveals a clear inverse correlation.These heuris-tic arguments can be supported by formal econometric analysis; Blecker(2002) reports that the dollar enters negatively and statistically significantlyin regressions of the manufacturing profit share and the manufacturinginvestment rate.Indeed, a hallmark of the current recession has been thecollapse in business fixed investment spending.The policy implications are clear.The overvalued dollar has contributedsignificantly to the current recession, and it now risks triggering a double-150 DOLLAR OVERVALUATION AND THE WORLD ECONOMYCopyright 2003 Institute for International Economics | http://www.iie.com dip recession.The benefits of Federal Reserve easing, mortgage refinanc-ings, tax cuts, and increased government spending have all been dilutedto the extent that spending has bled into imports.The inventory rebuildingof the first half of 2002 also had weaker employment effects to the extentthat it relied on imports.A robust sustained recovery will require renewedbusiness investment spending, but the likelihood of such spending isreduced as long as the overvalued dollar undermines domestic manufac-turers competitive position and creates incentives to shift productionoffshore.Long-Term Damage: Manufacturing andFinancial StabilityNot only has the overvalued dollar inflicted short-run damage on the USeconomy, it has also inflicted long-run damage.In September 2002 USmanufacturing employment fell to 16.6 million jobs, equal to the level ofJanuary 1962.This decline threatens the long-run commercial outlook forthe US economy.The threat is illustrated in the aircraft industry, whereBoeing has been forced to make significantly larger cuts to productionschedules than has Airbus.4 Given that airlines order on a fleet principle,sales lost today mean lost future sales, as airlines tend to stick with theircurrent supplier when placing new aircraft orders.In the textile industry, there were on average two mill closures a weekin 2001, and there were 240 mill closures between 1997 and September2002.5 Modern textile-making equipment from these closures is being soldoverseas in secondhand markets at rock-bottom prices.In this fashion, UScapacity is being permanently reduced while that of foreign competitors isbuilt up.Loss of manufacturing jobs carries a high cost
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