In a fruitless and pointless exercise, economic policy makers and businesses fret endlessly over the international value of currencies. This is because interventions to guide foreign exchange valuations tend to be costly and may have only temporary effect, at best.
Over the past year, the dollar's value measured by a trade-weighted index against a basket of currencies has declined by at least 10 percent. One reaction to this change has been lobbying efforts from the National Association of Manufacturers and the American Farm Bureau Federation against a strong dollar suggesting that a weaker dollar is "good" for the US economy.
Meanwhile, those in others believe that the relative strengthening of their currencies is bad for their economies. And so it is that central bankers and finance ministers in Japan and China have been accused of playing games that hinder the exchange rate of their currencies from appreciating against the US dollar. While Beijing resists revaluing its long-held peg of the renminbi against the dollar, Tokyo has spent the staggering sum of US$172 billion to try to keep the yen from rising further.
ILLUSTRATION: MOUNTAIN PEOPLE
In the case of Japan, an enormous amount of resources have been expended to support the yen. This has proved pointless on two grounds. It's yen has relentlessly continued to strengthen and the current account surplus has reached record levels. The latter being evidence that the position of the yen has had little impact of Japan's exports. Meanwhile, Beijing's intransigence has brought it the wrath of protectionists and self-inflicted wounds in terms of destabilizing its own macroeconomy.
Belief in the salutary effects of a depreciating currency is based partly on the expectation that rising exports of manufacturing production will increase employment and create economic growth. Careful thought on this issue suggests that most of the arguments relating to currency valuation reflect political thinking rather than sound economic logic. The most obvious evidence of weak economic thinking behind the ruminations over foreign exchange values is that the balance of trade is not the best measure of overall welfare.
It turns out that claims that a depreciating currency can increase the competitiveness of domestic producers are dubious. By themselves, increased exports arising from a depreciating currency do not cause per capita investment to rise.
This is clear if one understands the nature of economic growth. First there must be an adequate amount of savings to provide the fuel. Second, entrepreneurs act as the engine to guide investment funds towards viable long-term projects that create new jobs and a greater amount of wealth for the entire community.
In fact, currency depreciation should never be a policy objective since it can contribute to economic immiseration. It is chimerical to think when citizens of a country receive fewer real imports for a given amount of real exports it is an improvement in competitiveness. The country with a depreciating currency may receive additional units of foreign currencies, but it will possess less real wealth in the form of goods and services.
In the adjustment to the declining foreign value of a currency, exports tend to rise while imports tend to fall. This means that consumption must decline for citizens of the country with the depreciating currency since they receive less for what is sold to foreigners and more is paid for what is bought from foreigners. By any measure, this is a decline in overall living standards.
In all events, the supposed advantages created by depreciating currencies upon export sales or increased tourism are temporary. This is because domestic prices and wage rates eventually rise due to the new foreign exchange values. Obviously, a persistent rise in prices harms consumers while undermining long-term business investment and rising wages may also contribute to higher unemployment.
It turns out that most adherents of a weak dollar believe that economic growth depends upon aggregate demand for goods and services. According to this logic, increases in demand for goods and services can push up economic growth rates by triggering the production of goods and services. The implication is that policies that focus upon overall demand can promote economic growth.
This notion is also behind the "export-led" growth policies of many developing countries. Since exports are seen as contributing to economic growth while imports are portrayed as a drag on economic growth, they seek a weak currency so that the prices of domestic output are more attractive to foreigners.
These notions are based upon a misguided belief that increases or decreases in production can be traced to rising or falling overall demand for goods and services. The suggestion that consumption can precede production is based upon both logical impossibility and economic infeasibility.
It might be helpful to trace the impact of monetary policy on foreign exchange markets to see how a currency might depreciate. If the central bank or finance ministry wishes to push down the international value of the domestic currency, they buy foreign currencies. Increased supply of the domestic currency in money markets combined with increased demand for the foreign currency pushes down the value of the former while raising the value of the latter.
At this point, producers are better able to sell more exports. But it is important to know the source of the funds used to intervene in the foreign exchange markets. If they are drawn from existing currency supply, there would be a reduction in liquidity in the financial system. It is likely that the central bank would purchase government bonds, causing more local currency to be available.
Ultimately, loose monetary and credit policy cause the domestic prices of goods and services to rise. And then there will be a decline in profits earned from exports as well as domestic sales. And so it is that rising prices ends the illusion that prosperity can be conjured out of thin air by pumping new pieces of paper money into an economy.
A supreme irony emerges from the above logic whereby monetary policy responses to obsessions with international currency values increase the volatility of foreign exchange markets. So, what we are left with is that government interventions in markets at one level create a demand for the government to intervene at another level. And this cycle continues; ad infinitum and ad nauseum.
Christopher Lingle is professor of economics at Universidad Francisco Marroque in Guatemala and global strategist for eConoLytics.com.
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