The Exposure of U.S. Manufacturing Industries to Exchange Rates

Author Name Willem THORBECKE (Senior Fellow, RIETI)
Research Project East Asian Production Networks, Trade, Exchange Rates, and Global Imbalances
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This Non Technical Summary does not constitute part of the above-captioned Discussion Paper but has been prepared for the purpose of providing a bold outline of the paper, based on findings from the analysis for the paper and focusing primarily on their implications for policy. For details of the analysis, read the captioned Discussion Paper. Views expressed in this Non Technical Summary are solely those of the individual author(s), and do not necessarily represent the views of the Research Institute of Economy, Trade and Industry (RIETI).

Macroeconomy and Low Birthrate/Aging Population (FY2016-FY2019)
East Asian Production Networks, Trade, Exchange Rates, and Global Imbalances

The U.S. dollar remains the dominant reserve currency. Demand for the safety of dollar assets such as Treasury securities has strengthened the exchange rate and increased the U.S. current account deficit (see Caballero, Farhi, and Gourinchas, 2015). Currency manipulation may also have raised the dollar's value and worsened the current account. While these capital inflows allow Americans to consume more than they produce, the accompanying deficits cause dislocation for U.S. workers and industries. These deficits also generate protectionist pressures, as seen by the election of President Donald Trump on a protectionist platform.

This paper investigates what sectors in the United States are most exposed to exchange rates. To do this it employs cointegration analysis to investigate long run trade elasticities for manufacturing exports and imports in individual sectors. It also estimates exchange rate elasticities for imports from China and from other countries separately. The results indicate that U.S. exports of automobiles, toys, wood, aluminum, iron & steel, and several other goods tend to fall by more than 1% when the dollar appreciates by 1%. On the other hand, exports of sophisticated products such as pharmaceuticals and organic chemicals are not affected by exchange rates. On the import side, the findings are clearer when imports from China and other countries are investigated separately. For imports from China, exchange rate elasticities are close to unity or higher for footwear, radios, sports equipment, lamps, and watches. They are also greater than 0.5 for iron & steel, aluminum, miscellaneous manufacturing articles, and base metal tools. For imports from countries other than China, price elasticities are close to unity or higher for electrothermal appliances (e.g., water & space heaters), radios, furniture, lamps, and miscellaneous manufacturing articles. They are greater than 0.5 for aluminum, motor vehicles, and plastic articles. In addition, they are positive and statistically significant for several other categories and insignificant for pharmaceuticals.

To investigate how exchange rates affect manufacturing sectors, the paper also examines the stock market response of various industries to changes in the dollar. Theory posits that stock prices equal the expected present value of future net cash flows. Investigating how exchange rates affect sectoral stock returns can thus shed light on how industry profitability is affected.

As reported in Table 1, the paper finds that many of the same industries that export less and face greater import competition when the dollar appreciates also experience larger drops in stock prices. These include aluminum, iron, steel, forestry, paper, motor vehicles, and footwear. Other sectors with low elasticities of exports and imports such as pharmaceuticals and medical equipment also have low stock market exposures to exchange rates. Some sectors that purchase imported goods and sell them as consumer discretionary goods and apparel to U.S. customers benefit from a stronger dollar.

U.S. manufacturing imbalances are driving protectionist pressures. For example, Che, Lu, Schott, and Tao (2016) reported that counties in the U.S. that are most exposed to competition from China are also much more likely to support politicians who advocated protectionism. In December 2017, the U.S. Department of Commerce self-initiated antidumping (AD) and countervailing duty (CVD) cases against Chinese aluminum imports that many view as protectionist. It was the first time the Department of Commerce had self-initiated AD since 1985, when it initiated these cases against semiconductors from Japan. 1985 was a year when 99 seriously protectionist trade bills were introduced in Congress. In 1985, France, Germany, Japan, the United Kingdom, and the United States deflected protectionist pressures by working together to depreciate the dollar.

If the dollar is overvalued now, the United States and its trading partners should contemplate a similar accord involving more countries to weaken the dollar. In addition, they should consider lowering the dollar by promoting other currencies such as the euro, yen, and renminbi as alternative reserve currencies.

Table 1. Exposure of Industry Stock Returns to the Exchange Rate
Sector Exchange Rate Coeff. HAC Standard Error Adjusted R-squared S.E. of Regression
Aluminum -1.46*** 0.55 0.453 0.081
Nonferrous Metals -1.36*** 0.48 0.415 0.081
Paper -1.11*** 0.40 0.588 0.061
Forestry & Paper -1.06*** 0.39 0.611 0.058
Basic Resources -1.04*** 0.28 0.526 0.056
Ford Motor Co. -1.01 0.66 0.356 0.099
Iron & Steel -0.80*** 0.31 0.506 0.069
Commercial Vehicles & Trucks -0.73*** 0.26 0.587 0.050
Footwear -0.73* 0.40 0.218 0.072
Tires -0.70 0.54 0.447 0.097
Basic Materials -0.66*** 0.20 0.667 0.037
Oil & Gas -0.60*** 0.19 0.442 0.041
Commodity Chem. -0.52** 0.22 0.633 0.040
Automobiles -0.47 0.46 0.485 0.073
Specialty Chemicals -0.46* 0.25 0.551 0.037
Auto Parts -0.45 0.28 0.608 0.043
Aerospace -0.38* 0.23 0.562 0.040
Beverages -0.35* 0.20 0.306 0.039
Computer Hardware -0.31 0.24 0.665 0.047
Food Products -0.29* 0.17 0.356 0.031
Consumer Staples -0.27* 0.14 0.465 0.027
Clothing & Accessories -0.23 0.31 0.460 0.052
Medical Equipment -0.15 0.19 0.467 0.034
Biotechnology -0.13 0.29 0.427 0.060
Telecomm. Equip -0.12 0.21 0.721 0.047
Building Materials/Fixt. -0.11 0.20 0.658 0.039
Distillers & Vintners -0.10 0.30 0.245 0.049
Brewers 0.00 0.22 0.198 0.049
Furnishings 0.16 0.32 0.563 0.054
Consumer Discretionary 0.19* 0.11 0.803 0.022
Pharmaceuticals 0.22 0.16 0.441 0.034
Toys 0.27 0.30 0.219 0.026
Semiconductors 0.43 0.33 0.572 0.065
Apparel Rtl 0.80*** 0.31 0.379 0.061
Note: The table reports the coefficient on the exchange rate in a regression of industry stock returns on the exchange rate, the three Fama and French (FF) (1993) factors, and the five Chen, Roll, and Ross (CRR) (1986) factors. The exchange rate is the Federal Reserve broad effective exchange rate. The FF factors are the return on the market portfolio, the excess return on small capitalization stocks over large capitalization stocks, and the excess return of value stocks over growth stocks. The CRR factors are unexpected inflation, the change in expected inflation, the Treasury bond/Treasury bill spread, the corporate bond/Treasury bond spread, and the growth rate in industrial production.
*** (**) [*] denotes significance at the 1% (5%) [10%] levels.
  • Caballero, R., E. Farhi and P.-O. Gourinchas (2015), "Global Imbalances and Currency Wars at the ZLB," NBER Working Paper 21670, National Bureau of Economic Research.
  • Che, Y., Y. Lu, P. Schott, and Z. Tao (2016), "Does Trade Liberalization with China Influence U.S. Elections," NBER Working Paper No. 22178, National Bureau of Economic Research.