It has been more than two years since the value of the dollar began to plummet, yet America's trade deficit continues to soar, seemingly in defiance of the laws of economics.
The dollar has dropped from an average of 252 yen in 1984 to 129 yen last week, but our trade deficit with Japan has declined only slightly. Overall, the October gap between American merchandise exports and imports--$17.63 billion--set a record.
Last week, a group of distinguished international economists gathered at Brandeis University's Lemberg Center to puzzle out what is happening. Their conclusions were unusually depressing, in a profession seldom noted for its euphoria.
As Jeffrey Sachs, a noted Harvard economist, put it bluntly, "The equations don't hold up."
Though an over-valued dollar in the early 1980s indeed made American products less competitive in world markets, a cheaper dollar has not undone the damage.
That is a devastating conclusion, since it means that America's principal strategy for solving the trade gap--cheapening the currency--isn't working.
Our competitors are not using cheaper dollars to buy made-in-America products; they're using cheap dollars to buy up American firms and American real estate.
Why doesn't the strategy work? One reason why a 70% drop in the value of the dollar doesn't automatically lead to a 70% increase in the price of a Toyota is that Japan imports most of its raw materials, and those raw materials are priced in dollars.
Since 1985, Japan's index of wholesale prices has actually dropped by 15%. When a Japanese manufacturer pays less for materials, that holds down the dollar price of the finished product.
Second, Japanese and German manufacturers are very astute at competing on the basis of quality rather than price. As their currencies have become more expensive, they have compensated by making better products.
The price of the average Japanese car sold in America has risen since 1985, according to Prof. Ruyhei Wakasugi of Shinshu University, but only about half as much as the yen has risen. Yet the 1988 product is also a lot more car, so Americans keep buying.
Third, German and Japanese exporters have gradually moved some of their production to low-wage countries like Korea, Brazil or Mexico, whose own currencies are pegged to the dollar. When the dollar gets cheaper, labor costs get cheaper along with it.
Further, companies long in the export business, like those in Germany and Japan, are very good at adjusting their profit margins to compensate for the swings in currency values.
They've seen cheap dollars come and cheap dollars go. When the dollar is high, they reap above-average profits; when the dollar is low, they take a bit less. Over the long term, it all evens out.
The result, says economist Catherine Mann of the Federal Reserve Board staff, is a big departure from the predicted mechanical relationship between exchange rates and prices.
And since U.S. firms have simply stopped making some products, Americans keep buying those imports despite their higher price tags.
Most economists conclude nonetheless that the dollar has to decline further just to compensate for past declines in real American competitiveness. But unless U.S. firms also learn to compete in a world economy, an ever-cheaper dollar won't close the trade gap; it will only make us a poorer nation.
One national asset is the skill of the work force. The high-quality German and Japanese work forces reflect first-class educational and training systems. In Japan, a public school teacher is considered a high-prestige professional and is paid a salary comparable to a doctor's. In Germany, the government sponsors extensive apprenticeship programs.
And in both nations, interest rates are low, hostile corporate takeovers are unknown and firms look to the long term.
Until America learns some of those lessons as well as tricks of currency manipulation, the dollar can keep sinking beneath the waves but the trade picture is unlikely to improve.