Cline and Williamson have developed a measuring tool called the “fundamental equilibrium exchange rate” or FEER. It is defined as “an exchange rate that is expected to be indefinitely sustainable on the basis of existing policies.” It should generate a current account surplus or deficit that matches a country’s underlying capital flows, assuming the country is pursuing internal balance and not restricting trade for balance-of-payments reasons. FEER is defined in real terms after adjusting for inflation, and other factors, like productivity, are held constant. These estimates of exchange rates were first published in July 2008 using market conditions in March of 2008, before economic problems became evident, and again in June 2009 based on conditions in March 2009 when the dollar was at its peak as a safe haven. The latest estimates are based on conditions in December 2009.
The authors had four major conclusions important to U.S. agriculture about changes in the value of the dollar since March of 2009. First, the overvaluation of the dollar has been sharply reduced from 17 percent in March 2009 to 6 percent by the end of 2009 as the Federal Reserve’s trade weighted exchange index increased from 84.8 in March 2008 to 97.3 in March 2009 and reversed to 87.0 by December 2009.
Second, the overvaluation of the dollar would be eliminated if seriously undervalued exchange rates of five Asian economies were to appreciate: China by 41 percent, Hong Kong 32 percent, Malaysia 31 percent, Taiwan 29 percent, and Singapore 25 percent. The five are also undervalued against most other currencies.
Third, Australia, Brazil, Hungary, Indonesia and others experienced large appreciations relative to the dollar and went from undervaluations to substantial overvaluations due to high interest rates and carry-trade dynamics with U.S. short-term interest rates near zero. When the currency values for these countries are considered on a multilateral basis across all trading partners, they are not misaligned.
Fourth, Canada and Mexico both moved from slight undervaluation in March 2009 to 9-10 percent overvaluations by December.
A few other important changes occurred for countries that are either agricultural markets for the U.S. or competitors in third country markets. The Euro went from 17 percent undervalued in March to 7 percent undervalued by December. Japan’s undervaluation improved slightly from 20 percent to 16 percent. The Korean Won was also undervalued by about 15 percent in December 2009. If the five undervalued East Asian currencies increased in value, the Yen and the Won would need to make smaller adjustment in relation to the dollar.
Despite major changes in the value of the dollar caused by the safe haven affect and reversal of that over the past nine months, U.S. agricultural exports have held up reasonably well. According the Economic Research Service of USDA, exports in fiscal year (FY) 2009, October 2008-September 2009, in the heart of the slowdown were $96.6 billion, down from the record high of $115.3 billion in FY 2008. That high was due to a combination of higher volumes and higher prices. Exports for FY2009 were still up $14.4 billion from FY2007 and $28.0 billion from FY 2006. Agricultural exports for FY2010 are expected to be up $1.4 billion to $98.0 billion.
Grains and feeds alone accounted for $12.0 billion of the $18.7 billion decline in exports for FY2008 to FY2009, but were up $2.1 billion from FY2007 and expected to be about unchanged for FY2010. Oilseeds and products did much better with only a $1.8 billion decline from FY2008 to FY2009 and up $7.3 billion from FY2007. They are expected to be down $0.6 billion for FY2010. Livestock, poultry and dairy products were down $3.4 billion in FY2009 over FY2008, but still up $2.4 billion from FY2007, and expected to be up $1.1 billion in 2010. Dairy products were $1.7 billion of the $3.4 billion decline in FY2009. Horticultural product exports had a $0.2 billion decline in FY2009 and are forecast to be up $0.9 billion in FY2010.
Exports by country do not always follow the exchange rate trends. Overall agricultural exports declined by 16.2 percent from FY2008 to FY2009. Canada, the number one market for the U.S., had a 4.9 percent decline in imports with a stronger currency, while Mexico, the number two market, had a 13.5 percent decline with the same change in the relative strength of the peso. Japan had a 14.5 percent decline in imports as its Yen remained about unchanged. Japan is a mature market and the decline was due to market prices not volume. The EU had a 29 percent decline for FY2009 over FY2008, with only a slight uptick expected for 2010.
Those five Asian countries with large undervaluations are also significant buyers of U.S. agricultural products. In theory, stronger currencies would allow them to buy more U.S. products. Hong Kong’s imports were actually up $0.2 billion in FY2009 to $1.8 billion and are expected be the same for FY2010. China’s imports were flat in FY2009 relative to FY2008 at $11.2 billion and are expected to be the same for FY2010. Malaysia was down slight in FY2009 at $0.6 billion and expected to be unchanged in FY2010. These are strong economies with growing middle classes that want a more varied diet and can afford to pay even with weak currencies.
The dollar could strengthen when the Federal Reserve ends is low interest rate policies. Currency values have an impact on markets, particularly for commodity markets like wheat where the pass through of currency values can be rapid. Economic growth and internal demand growth generally have a bigger impact, even in the midst of a worldwide economic crisis. Currency policy is one part of a larger economic policy framework of open markets that leads to growing demand for U.S. agricultural products.