Well, maybe not anymore. And perhaps not even before.
The quote is from an article on how the weak dollar is raising the costs of traveling to Europe, as the USD/EUR rate flirts with 1.40. The longer quote, from yesterday’s NYT article entitled “As Dollar Crumples, Tourists Overseas Reel”
Among some, there is even a sense that turnabout is fair play. Linda Miller, a frequent visitor to Europe from Honolulu, was browsing the other day in the gift shop at the National Gallery of Ireland in Dublin.
Recalling how she and her husband, Stephen, an eye surgeon, had lived large on earlier trips to Europe, Ms. Miller said, “We have always thought that America got away with something.”
While this phenomenon is well known to recent travelers to Europe, it bears repeating, especially as many observers are wont to take the stabilization in the US net international investment position to GDP ratio as unabashed good news.
Figure 1: Ratio of net international investment position divided by nominal end-year GDP, excluding derivatives, and valuing FDI at market value. Source: Author’s calculations based on BEA 2006 IIP release, and NIPA release of June 28, 2007.
The increase in the number of bundles of real U.S. goods and services required to get a single bundle of euro area goods and services highlights the fact that the dollar depreciation over the past five years — which has upwardly revalued U.S. owned assets abroad — also implies a reduction in the terms of trade.
The impact of this relative price effect on GDP is accounted for in the terms-of-trade adjusted GDP series. The Penn World Tables reports this real GDP (in PPP terms) adjusted for terms-of-trade effects, as well as the more conventional GDP adjusted into PPP terms. The (log) ratio of the latter by the former, and the real value of the US dollar (as measured in broad terms by the Fed) are plotted in Figure 2. The stronger the dollar, the larger the terms-of-trade adjusted GDP relative to GDP.
Figure 2: Log ratio of terms-of-trade adjusted GDP to unadjusted GDP (in International dollars, Laspeyres index) and log real value of US dollar against broad basket of curencies. 2007 value of dollar based on first six months. Source: Author’s calculations based on Penn World Tables series RGDPTT and RGDPL, and Federal Reserve Board.
The relationship is pretty strong over the past 15 years; in the earlier period it is less pronounced — but that is to be expected. The terms-of-trade effect is larger the greater (in absolute value) the trade balance to GDP ratio. Regressing the log ratio on the log real value of the dollar leads to the following results:
ratio = -0.18 + 0.04 r
Adj.R2 = 0.79; SER = 0.0017
Where r is the real value of the US dollar. Note that the coefficient on r is statistically significant.
Using this equation to fit the ratio leads to the following figure.
Figure 3: Actual log ratio of terms-of-trade adjusted GDP to unadjusted GDP (in International dollars, Laspeyres index) predicted values. Gray shading denotes forecast period. Source: Author’s calculations based on Penn World Tables series RGDPTT and RGDPL, and Federal Reserve Board.
In other words, from 1998 (in the wake of the East Asian crisis) up until 2002 (with a year’s exception), the US benefitted from the strong dollar; since then, the depreciating dollar has lead to an erosion of this effect. As of the first half of 2007, the effect is such that the terms-of-trade adjusted GDP is less than the unadjusted GDP. The 0.007 percentage point shift implies a relative loss of about $81 billion (in 2000$). That effect will continue to increase as long as the dollar continues to decline.
(See Truman (2005) [pdf] for a different estimate of terms of trade loss — roughly $300 billion for a 30% nominal depreciation.)