By J.N. Tlaga

Between January 3 and April 18 of 1995, the value of US dollar in Japanese yen declined 20% from 100 to 80 yen. This 20% drop created automatic 20% price subsidy in Japan for American-made products, and corresponding 25% tariff in America on Japanese-made products.

To be sure, no one was subsidizing Chrysler to sell cars in Japan at 20% discount, and no one was imposing import duty on Mitsubishi cars to raise their prices in America by 25%. It was the shift in dollar-yen exchange rate that was responsible for this effect. The principle is very simple. When one dollar is worth 100 yen, a 20,000-dollar car costs 2,000,000 yen, and a 2,000,000-yen car costs 20,000 dollars. But when the price of one dollar goes down to 80 yen, the price of the same 20,000-dollar car goes down to 1,600,000 yen, and the price of the same 2,000,000-yen car goes up to 25,000 dollars.

It would be rational to expect that so dramatic a change in terms of trade between dollar-denominated and yen-denominated markets would arrest, if not reverse, the persistent negative balance of trade between United States and Japan, but in reality nothing of the sort was happening. Was it possible for the US dollar to be so overvalued that one-fifth decline was not big enough to reach the level of equilibrium?

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