EMU Exports And Imports Hit A One-Month Backtrack But Is The Surplus Really On A Sustained Declining Trend?

The seasonally adjusted and working day adjusted EMU trade balance improved in April widening to €1.39Bln surplus. Still, the trend is for the surplus to shrink. Growth rates show that exports and imports are building on the earlier strong rates of growth, getting successively larger over more recent periods- even with this month's backtracking.

Export and import categories are off across the board this month with one exception, a monthly rise in the export value of raw materials

The chart above shows a pattern for the surplus is that it is slowly deteriorating after peaking early in 2009. This is interesting because if European growth gets weak we would expect this pattern to reverse and to produce surpluses as growth slows and as imports slow down as domestic demand weakens. But, we also expect Europe to stave off surplus reduction because the euro is weak and the increase in competitiveness should expand exports and retard imports. The fact of the ongoing current surplus deterioration suggests that there is a J-Curve at work. The rise in the surplus this month may hint that we have reached the end of the J-curve effect. So, let's look at how that works.

The J-curve refers to the tendency for traded goods prices to react first to the change in the exchange rate and for trade volumes to react later. There is a timing asymmetry; in fact, there are probably several of them. For example, with the euro's fall in value there is not necessarily an immediate impact on export prices. Export prices are denominated in euros based on their euro-area costs. But export volumes eventually will respond positively to the exchange rate drop because unchanged euro-based export prices will translate them into much lower foreign currency prices.

Initially nothing happens to export prices. Secondly, the volume sold overseas eventually grows as overseas buyers respond to lower prices expressed in their domestic currency. Thirdly, eventually European exporters might even RAISE their euro prices to increase their profits more immediately, and blunt the degree of competitiveness improvement. But these latter two effects are second and third round occurrences. The initial effect on exports and export prices is that nothing much happens due to the exchange rate change.

Import prices, however, are under pressure from the very start of the currency weakening. The minute that the euro falls, foreign prices expressed in euro currency terms are adjusted up. For example $70/bbl oil that used to cost €  53.85 at € 1.30 will require € 58.33 at € 1.20. So the terms of trade (PX/PM) move sharply against a country as a first step after a currency drop. That means that the ratio drops as import prices rise faster then export prices (...and all other things the same, that will widen the trade deficit). But eventually because demand elasticities (demand responsiveness) are greater than one in absolute value, the percentage drop in import volumes will surpass the percentage rise in import prices, bringing about a drop in the value of imports and a rise in the trade surplus.

And, as discussed above, eventually the drop in foreign currency prices for exports will spur export volumes to expand in foreign markets. Both of these effects argue for an expanded surplus, eventually. But the immediate impact is that surplus gets smaller because price effects take place before demand impacts play out. The deterioration in the terms of trade is the dominant first-round effect and that creates the J-curve, a move in the wrong direction before a move in the right direction. Right now the combination of the J-curve effects driving up import prices up and stronger recovery growth sucking in imports is wining the battle against strong exports driven by a strong overseas recovery. As a result the surplus is shrinking. This is the first round, or the start of the J-curve effect, It is temporary and with the euro's drop slowing the one month rise in the trade surplus could be a hint of things to come.

Weaker growth in EMU could stem the ongoing rise in imports too, but so will the eventual response to higher import prices as the euro has fallen. One of theses effects will do it by enhancing growth; the other by retarding it. There will be little confusion about which effect is winning out. Either way, we expect Europe's surplus to return for good and for this declining phase in the surplus to prove temporary. Perhaps the rise in the monthly surplus is the start of that process.

Euro-Area Trade trends for goods   m/m% % Saar     Apr-10 Mar-10 3M 6M 12M 12M Ago Balance* € 1,397 € (26) € (1,435) € 1,870 € (3,931) € 219 Exports All Exp -2.4% 9.8% 51.2% 27.2% 17.4% -24.3% Food and Drinks -2.9% 6.2% 22.4% 19.2% 7.9% -10.0% Raw materials 0.8% 6.5% 54.5% 39.3% 31.6% -25.3% Other -2.4% 10.1% 53.6% 27.6% 17.8% -25.3% MFG -4.8% 12.1% 43.9% 21.2% 14.8% -23.4% IMPORTS All IMP -3.5% 12.2% 49.0% 32.7% 17.3% -25.1% Food and Drinks -2.4% 5.5% -4.4% 11.0% -1.8% -4.9% Raw materials -5.0% 22.9% 96.7% 68.8% 40.0% -37.9% Other -3.5% 12.1% 51.5% 32.7% 17.8% -25.7% MFG -5.1% 12.6% 31.9% 28.4% 14.1% -21.0% *Eur mlns; mo or period average (SA, WDA)