Tobold's Blog
Wednesday, June 14, 2017
 
Devaluation

60 years ago, in 1957, the USA threatened Britain to sell off a bunch of Sterling denominated bonds, which would have driven down the value of the British pound. At that point in time your currency losing value compared to others was considered such a scary idea, that Britain caved in and withdrew their troops from Suez, ending the Suez crisis (and some say the British Empire). If your currency loses value, all the money that your citizens have is worth less, and prices go up because everything imported becomes more expensive. I haven't quite understood how we got from that very reasonable fear of devaluation in 1957 to the idea that devaluation is good for the economy in 2017.

The only possible explanation that I have is that it is some sort of short-term thinking. A sudden drop in value of a currency, like the drop of the value of the British pound from the Brexit referendum, in the short term leads to a countries exports becoming cheaper. Exports go up, the trade balance goes up, and the GDP goes up. However sooner or later the country's stock of raw materials bought before the devaluation runs out. Now the imported materials are more expensive, and at some point the manufacturer of goods needs to raise his prices to compensate for that. In theory, that is in a system where nothing else changes, the price goes up by exactly as much as it had previously dropped from the devaluation of the currency, and the result on exported goods prices is zero. However the effect of devaluation on the price of imported goods isn't zero, and everybody gets less goods for their money. So I still think that devaluation is not good for an economy in the long run.

Curiously devaluation also has a rather socialist component: It hurts people who have money in that currency, and helps people who have debts in that currency. Devaluation is a form of redistribution from the haves to the have-nots. So maybe that is why governments like it these days, because all governments are heavily indebted, and devaluation is a sneaky form of taxation. However it doesn't just hurt the rich, but also those who have entitlements, like pensions. The British pensioner living at the Costa del Sol in Spain probably feels the devaluation of the British pound more than anybody else. The really rich are more likely to have their money in more than one currency, and what they lose on their British pounds they gain on their Swiss francs.

There is an idea discussed in Europe that dissolving the currency union of the Euro would solve economic problems by making the returned German mark more valuable, and devalue the currencies of the weaker economies like Greece or Italy. I don't see how devaluing their currencies will solve the economic problems of those countries in the long run. And while exports of Germany sure would take a hit in the short term, I don't see how doubling the value of their money would hurt the Germans terribly in the long run. It wasn't as if Germany was poor and Greece and Italy were rich before the currency union. The main practical problem of dissolving the Euro would be that *everybody* in the currency union would want their Euros transformed into German marks, and nobody would want Greek drachmas or Italian lira. It would need really heavy-handed state intervention to force the citizens of each Euro-zone country to take their own national money back.

I think the politicians of 1957 got it right: Your own currency being valuable to other people is an asset, not an obstacle.

Comments:
You're forgetting the cost of labor. Devaluing your currency is equivalent to lowering the wages of all the workers compared to the foreign workers. So the effect is long term, unless your economy relies on imports: if it does you have a bigger problem, anyway.
The problem is also that the opposite is suicidal, if you're increasing the value of your currency, i.e. prices drop, i.e. deflation, this kills local investment as no-one will risk taking loans. Our economy relies on growth to exist (with 0% growth, a capitalist economy implodes), so you need a way to finance it even when there's no money available for it. Loans do exactly this, and you need inflation to keep them interesting.


 
IMO, you raised two issues: strong/weak currency and common currency.

https://www.project-syndicate.org/commentary/the-euro--monetary-unity-to-political-disunity

The way you get people to value a currency is to have higher interest rates. If the ECB or US Fed raise interest rates, the currency is worth more. Lowering your interest rates makes your currency weaker which raises the price of imports which discourages them and lowers the price others pay for your exports, which helps exporters. It is a way to get out of a recession and increase inflation. Failing American manufacturers claimed Japan (80s) and now China kept currency low to help exports. Sometimes rich export industries have better lobbies than the voters who will have to pay more for all their imported goods. As central banks adjust interest rates between combatting recession and inflation, the problem now is that the interest rates in Germany and Bulgaria/Greece/Italy must be the same and yet they may not be at the same place on the economic cycle.
 
There are pros and cons when it comes to devaluation. My impression is that economists generally approve of a small steady amount of inflation, which is currency devaluation under another name, except it can apply to all currencies at once. Inflation makes the economy more flexible, since it causes the values of prices, rents, wages and entitlements to drop automatically over time, which is not always easy to negotiate in the normal way when appropriate.

Relative devaluation, which is what Tobold is speaking of, is a thornier issue. In principle, everything should work out after the disruption. Certainly the disruptions are neither all beneficial nor all deleterious to the inhabitants of a given country - there are winners and losers. If Sterling should collapse, for example, British computer game developers will do very well out of it.

It ties in with arguments relating to globalism, protectionism etc. Economists often like to pretend the simplistic equations in their textbooks, which favour frictionless economics, are all there is to know. But in the real world, the knock-on effects of macroeconomic changes can be complex.
 
Same as Hagu (interest rates affect currency) and Helistar (devaluation makes local labour cheaper) plus exchange fluctuations traditionally keep countries in approximate parity cost and equalising competitive advantage.
For example, if one country produces an identical product more cheaply than a second country customers will buy from the first country. They must buy the first country's currency to pay for the product which raises that currencies exchange rate relative to the second country and pushing the effective costs for both countries closer together.
That cannot work if both countries are in a currency union. Other actions are required to rebalance the regions such as cash transfers, investment spending or localised deregulation.
 
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