The collapse of Bretton Woods in 1971 (a result of Nixon decoupling the US dollar from gold) tested our understanding of the role of nominal exchange rate volatility on trade and the real economy. Although the IMF concluded in the 1980s that it was unlikely that increased volatility would have a significant negative impact on trade volume, it was less clear how volatility (and potential manipulation) would affect resource allocation and bilateral trade imbalances.
With trade and currency manipulation back in the news, I was interested in visually exploring the relationships between exports, exchange rates, and purchasing power parity (through The Economist's Big Mac Index). Using data from the US Census, WTO, and The Economist, I looked at the changes in these areas from 2006 through 2017.
The Big Mac index, a highly imperfect measure, should in a perfect world track exchange rate one-to-one over the medium to long-run (accounting for price stickiness and local variations in input prices). Otherwise, it is intended to illustrate where a currency may be artificially under or overvalued. Above, we can see that indeed they do closely track one another (-0.72 correlation coefficient), with some notable country-level variations (the correlation between the renminbi/dollar exchange and big mac price was -0.85- perhaps signaling a quicker price adjustment in a larger market for McDonalds).
More interesting to me, is the stark inverse relationship between exports and the exchange rate (-0.48 correlation coefficient). It is well established that a relatively cheap currency increases exports, but the juxtaposition was nonetheless a little surprising. Below, you can see the relationship looking only at Chinese exchange rate and export data (which account for 22.5% of US imports).
(Yellow = Exchange Rate, Brown = Exports)
Please fill in the contact form below to have new articles emailed to you directly!