(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000606350001-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 10
• Document Creation Date: January 12, 2017
• Document Release Date: March 22, 2011
• Sequence Number: 1
• Publication Date: August 19, 1986
• Content Type: MEMO

Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86TO1017R000606350001-0 F/
25X1
Central Intelligence Agency
DOC NO tai 1 M 8(o -~OIl C7 Washington.D.C20505
OIR
DATE - / ai &L, 'f-1 L E;
P $PD I
DIRECTORATE OF INTELLIGENCE
19 August 1986
The US-Japan Trade Imbalance: Even Larger in 1986
Summary
The 55-percent appreciation of the yen relative to the dollar since
last September has not yet dented the massive imbalance in trade
between Japan and the United States. Tokyo apparently expects the
announcement of another record surplus to generate increased trade
tension, although we see no signs of a Japanese strategy to head off new
trade restrictions. Based on data for the first seven months of 1986,
supplemented by projections from the CIA's econometric model of Japan,
we believe that Japan's surplus will be at least $10 billion higher than
1985's record level.
Most of the increase in Japan's trade surplus with the United States
is occurring because US importers, at least for a time, continued to import
about the same quantity of Japanese products, even though the dollar
prices of these exports rose sharply following the yen appreciation that
began about a year ago. The sluggishness of the Japanese economy in
the first half of the year also reduced Japanese imports from the United
This memorandum was prepared by
Office of East
25X1
Asian Analysis, and with a contribution fro
O
ffice of Information
Resources. Informatio
Comments and querie
n available as of 19 August 1986 was
s are welcome and may be directed to
use
th
d in its preparation.
e Chief, Japan Branch,
Northeast Asia Divisio
n, OEA
25X1
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
States, widening the trade imbalance. A further strengthening of the yen
or an acceleration in US economic growth compared with growth in Ja an
this fall could add another $5 billion to the trade imbalance in 1986.
The Ballooning Deficit
Japan's large trade surplus with the United States is getting worse. In the first
seven months of this year, the surplus totalled $27.5 billion--a third higher than the
same period last year.1 The value of Japanese exports to the United States grew by 25
percent with increases registered in every major product category except iron and steel.
At the same time, Japanese imports from the United States showed only a marginal
The United States is not the only country to feel the impact of the recent
Japanese trade expansion. Indeed, the US share accounted for only 60 percent of
Japan's overall trade surplus of $46.3 billion in the first seven months of 1986, compared
with 70 percent of the total for the same period last year. This drop largely reflects the
rapid Japanese gains in exports to the EC market--particularly in electronic products
and automobiles--as well as the sharp decline in oil prices which should reduce the
value of Japan's oil imports by some $15 billion in 1986. The decline in oil imports, in
fact, will probably leave Tokyo with a small trade surplus with developing countries this
year, compared with an $11 billion deficit in 1985.
Factors Behind the Runup
In our view, the rapid increase in the US-Japan trade imbalance during the first
half of 1986 results primarily from the higher dollar prices of Japanese exports and the
slow response of export volume to yen appreciation--the so-called J-curve effect.
Export volumes have declined only 2 percent so far this year compared with their levels
a year ago. Slow economic growth in Japan compared with the US economy has also
The J-curve effect. As the yen appreciated against the US dollar in late 1985
and early this year, the dollar price of Japan's exports increased rapidly. Japanese
exporters with contracts denominated in yen--about 40 percent of Japan's total export
contracts b-received more dollars for approximately 25X1
the same volume of overseas shipments. Export volumes generally react slowly to a
price increase. In the Japanese case, according to our econometric model of Japan,
only 40 percent of the volume response occurs in the first two quarters after a price
increase. Initially, therefore, following the yen appreciation of 1985-86, the dollar value
Our bilateral trade numbers are based on Japanese trade statistics which differ from
those calculated by the US Commerce Department. In 1985, the trade deficit by US
standards was roughly $10 billion larger than the deficit by Japanese standards, on
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
of Japan's exports increased sharply. Our estimates indicate the J-curve effect
increased Japan's surplus with the United States by nearly $10 billion in the first half of
this year.
The J-curve effect--and thus the widening of the trade surplus--would have
been even more pronounced if Japanese firms had not moved to cut costs and trim
their yen prices to maintain market share abroad.
Japanese companies have on average lowered their yen export prices by 15
percent since the yen began appreciating last summer.
firms have trimmed their production costs by importing components
from lower wage countries--such as South Korea, Taiwan, and Singapore--as well as by
reducing payments to Japanese subcontractors. The short-term effect of this strategy
has been to hold down the dollar price of exports and therefore--given the relatively
constant US demand for Japanese products--to limit the increase in Japan's surplus.
According to our estimates, if Japanese firms had maintained their yen prices and
therefore raised dollar prices by the full amount of the appreciation, the US-Japan trade
imbalance would have risen another $6 billion higher over its levels for the first half of
1986. In the longer run, if the Japanese hold prices down, it will mitigate the tendency
of the appreciation to lower demand for Japan's exports.
Economic Growth in Japan and the United States. Japanese output fell in the
first quarter of this year, contracting at a 2.1 percent annual rate--the first quarterly
drop in 11 years--and the slowdown will probably last for the rest of the year. The yen
appreciation has trimmed export volumes, reducing profit margins and forcing cutbacks
in spending on industrial equipment. From the perspective of the US-Japan trade
imbalance, the slowdown in growth--by holding down Japanese imports--has helped to
expand the bilateral trade surplus. Our econometric model suggests that for each one
percentage point decline in Japanese growth, Japan's trade surplus with the United
States increases approximately $3 billion.
We believe the growth in the bilateral trade imbalance will slow somewhat in the
remainder of the year, with Japan's 1986 trade surplus approaching $50 billion
(approximately $60 billion by US standards). This is $10 billion more than last year's
record. An expected decrease in Japanese export volume largely accounts for the
slower growth in the surplus. By yearend 1986, two-thirds of the downturn in export
volume stemming from the price increases early this year will have occurred. We base
our judgment on the swing in export volume in part on the recent sharp reduction in
signed export contracts--particularly for machinery orders. Such contracts now have
declined for five consecutive months and we expect the impact on export volumes to
start appearing soon.
25X1
25X1
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
Our projection of the US-Japan trade imbalance assumes that the yen-dollar
exchange rate remains fairly stable at 155 yen to the dollar for the remainder of the
year. The yen could appreciate further--a development that would again increase the
dollar price of Japan's exports and further widen the trade imbalance. If the yen
strengthens to 130 to the dollar by the end of the year, our model suggests the J-curve
effect would push the US-Japan trade imbalance to $58 billion--$8 billion higher than
A change in Japanese or US growth would influence the trade balance to a lesser
extent. If the US economy grows more rapidly--as some economists are now
predicting--Japan's trade surplus with the United States would increase as US
consumers and firms expand their purchases. Faster growth in the US
economy--enough to raise US output in 1986 by an additional percentage point over the
baseline--would raise the surplus by almost $1 billion, according to our model. We
caution, however, that the model may underestimate the effect of US growth because
the model fails to take account of the impact of US growth on the rest of world and the
consequent additional increase in Japanese exports. Thus, if US growth does accelerate,
Japan's surplus could even be higher. Indeed, some US banks are projecting that the
bilateral trade surplus could reach nearly $70 billion this year, although their
assumptions about exchange rates and growth are not clear.
The View From Tokyo
Past experience would suggest that the Japanese expect US press attention and
political criticism to renew when the extent of the trade imbalance becomes clear.
We believe the Japanese Government will
remain in its traditional reactive mode--waiting for the United States or other trading
partners to threaten additional trade restrictions--before taking any politically difficult
steps to narrow the trade imbalance.
If US legislative action or other pressures arise, Tokyo will quickly develop a
strategy to deal with increased "protectionist threats." Under current conditions, a
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
possible Japanese tack would be to point out that the expanding trade balance is a
short-term phenomenon and will erode over time because of the yen appreciation. F-I 25X1
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
Figure 1
Japan: Trade with the United States
Exports
mports
1978 1979 1980 1981 1982 1983 1984 1985
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
Figure 2
Japan: Export Volume Response to
10 Percent Yen Appreciation*
-~ T
1 2 3 4 5 6 7 8
Quarters from Appreciation
*Based on our econometric mode! of Japan.
10 11 12
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86TO1017R000606350001-0
 c
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
Figure 3
Japan: Effect on Trade Surplus of
10 Percent Yen Appreciation*
15-,
10
-5
-10
0 1 2 3 4 5 6 7 8 9 10 11 12
Quarters from Appreciation
*Based on our econometric model of Japan.
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
Title: The US-Japan Trade Imbalance:
Even Larger in 1986
1 - Requestor, Michael Smith, Deputy USTR
- Joseph Massey, USTR
- Bob Park, Intelligence Liaison, USTR
- Donald Gregg, Office of the Vice President
- Thomas Hubbard, Department of State
- William Brooks, Department of State
- Chuck Kartman, Department of State
- John Malott, Department of State
- Marshall Casse, Department of State
- Rea Brazeal, Department of State
- Nicholas Riegg, Department of State
- James Kelley, Staff Member NSC
- Cdr. (Ret.) James Auer, DOD/ISA/EAP
- Stephen Danzansky, National Security Council
- Louis Pugliariesi, National Security Council
- Byron Jackson, Department of Commerce
- Allen Lenz, Department of Commerce
- Mel Searles, Department of Commerce
- Maureen Smith, Department of Commerce
- Doug Mulholland, Department of the Treasury
- Richard Fauver, Department of the Treasury
- Richard Woodworth, Department of the Treasury
- David Germany, Council of Economic Advisers
Central Intelligence Agency
1 - Director, DCI/DDCI Executive Staff (7D60)
1 - NIO/EA, 7E-62
1 - NIO/Economics
1 -C/E
1 - OGI/IIC/PI
1 - OEA/NEA/Korea Branch
1 - OEA/NEA/STI Branch
1 - OEA/NEA Division
1 - OEA/China Division
1 - OEA/SEA Division
1 - D/OEA, 4F-18
1 - C/Research/OEA
1 - FBIS Analysis Group
1 - DDI, 7E-44
1 - Senior Review Panel, 5G-00
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
 Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0
1 - PDB Staff, 7F-30
1 - C/PES, 7F-24
1 - CPAS/ILS, 7G-50
5 - CPAS/IMC/CB, 7G-07
1 - Branch
1 - C/PES, 7F-24
1 - NIC/AG, 7E-47
1 - DDO/EA Division
1 - DDO
1-
2 - Author
1 - Chro
DDI/OEAJ
(19 Aug. 86)
25X1
25X1
Sanitized Copy Approved for Release 2011/03/22 : CIA-RDP86T01017R000606350001-0