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WASHINGTON, DC - The last thing we need is the designation of another New Era'' to characterize every new phenomenon that comes down the pike.
 
That said, we need some way to explain the improvement in the US trade balance with the rest of the world in the last two quarters without the usual shift in relative prices.
 
"It's a virgin birth," says Bob Barbera, chief economist at ITG/Hoenig in Rye Brook, New York.
In the old model, a decline in the value of the currency leads to a change in the relative prices of goods. Consumers substitute domestic goods for imports; exports became more attractive.
 
The improvement in the trade deficit doesn't come right away, however. The increased price of imports (the currency buys less) initially overwhelms the shift in preferences: from imports to domestic goods at home; from domestic goods to imports abroad. The phenomenon, graphed, looks like the letter "J;" hence, in economists' terms, "the J-curve effect."

Eventually the volume of imports declines enough to improve the trade balance.
 
This time around, a big decline in the US dollar - the trade-weighted dollar fell about 16 percent last year - has had no effect on the price of core consumer goods and only a negligible effect on import prices.
 
In other words, "the shift in exports and imports has come about without a shift in relative prices," Barbera says. "It's not supposed to happen that way."
 
Not supposed to, but seems to, nonetheless.
 
Barbera has a hypothesis - "more like a kernel of an idea," he says - as to why.
 
The old model "assumes companies are domiciled in countries," he says. "Now we have multinational companies. A big swing in the currency leads to a big swing in relative unit labor costs."

Instead of a shift in prices, what's shifting is where things are produced.
 
For example, with the 17% decline in the dollar versus the euro in 2003, it makes more sense for BMW to produce cars in South Carolina than in Munich. Even though BMW has its headquarters in Germany, its US-produced cars sold in France are counted as US exports.
 
Now, BMW may not produce identical models here and there. And producers generally need to see "wrenching shifts" before they move production from one locale to another, especially if it entails a capital investment, says Joe Carson, head of global economic research at Alliance Capital Management.
 
Still, in an environment where industrialized nations are struggling to compete with the developing world and its cheap labor, companies may be quicker to capitalize on shifts in their costs.
 
US exports rose 2.9% in November to a three-year high, and while imports fell 0.8%. Together, they shaved the trade deficit by 8.6% to a 14-month low of $38 billion. While December could show a nasty reversal, it appears trade won't subtract from fourth-quarter growth, prompting economists to mark up their GDP forecasts roughly to 5% from 4%.
 
Total exports soared at a 35% annualized rate in the three months ended November as the dollar's deterioration accelerated.
 
In the 12 months ended November, exports rose 9.3% while imports gained 5.8%.
 
US goods exports to China set a monthly record of $3.3 billion in November. For the year ended November, US goods exports to China soared 53.8%, more than four times the increase in Chinese imports.
 
The politicians may have to change their story: about China stealing our manufacturing jobs (China's losing manufacturing jobs - to productivity); about the loss of US export competitiveness; about the need to impose trade sanctions to ameliorate it.
 
More curious than the sharp jump in exports is the tepid growth of imports in light of booming second-half U.S. economic growth. The high-income elasticity of imports -- when we grow a lot, we import a lot - would have suggested a surge in imports. Instead, total imports rose an annualized 18.5% in the three months ended November, about half the pace of export growth.
 
The Institute for Supply Management's monthly survey has been hinting at increased export demand. The ISM new export order index rose to a 14-year high of 60.4 in December, suggesting further export growth.
 
"It's reasonable to assume that export orders haven't fully responded to the drop in the dollar," says Ian Shepherdson, chief US economist at High Frequency Economics in Valhalla, New York.
 
Gross exports (not net exports) could be the single largest contributor to growth this year, a result of the dollar coming off and the dollar liquidity coming back as a stronger world economy,'' says Neal Soss, chief economist at Credit Suisse First Boston.
 
Soss is less sanguine about the overall trade balance and expects a resumption of imports to widen the deficit and subtract modestly from 2004 growth.
 
The negligible pass-through to date of the dollar decline to prices notwithstanding, Shepherdson thinks it ultimately will contribute to more inflation than the Federal Reserve thinks.
 
In a January 4 speech to the American Economics Association annual meeting in San Diego, Fed Governor Ben Bernanke said that "a 10 percent decline in the broad value of the dollar would be expected to add between one and three tenths to the level of core consumer prices (not the inflation rate), spread out over a period of time."

The trade-weighted dollar index has fallen about 26% in nominal terms and 12% in inflation-adjusted terms since its high in January, 2002.

If Barbera is correct in the ability of the trade balance to adjust without a change in relative prices, the economics textbooks will have to be updated.

If he's wrong, then it won't be the first new era to become an old error.

Go back, or read the latest opinions:

''On the Waterfront – Still''

John Fund, Wall Street Journal, 09/17/06