In the modern age of mega-democracies and Bretton Woods/Keynesian print and inflate economic models, countries constantly complain about the currency manipulation of their trading partners. The crux of the issue is that certain countries purposely keep their currencies weak in order to make their exports less expensive and therefore more competitive. Populist politicians claim that this is an “unfair advantage,” which costs their constituents jobs. For example, it’s hard to hear the word “China” come out of the mouth of an American politician without some kind of mention of currency manipulation. They aren’t the only ones complaining though. Countries such as Japan and Switzerland have even taken the drastic step of selling their own currencies on the foreign exchange market in an effort to weaken them.
The reality is quite different than what one hears from populist politicians and the alarmist mainstream media however. If one understands economics, then they know that complaining about a countries’ weak currency is both foolish and illogical. The drawbacks to weakening a currency far outweigh the positive benefits; although the positive benefits are felt the fastest, and therefore the most popular among the electorate. A weak currency may help a nation’s exporters, but that benefit is often short lived because it also increases the prices of the underlying commodities which are needed to produce the product being exported. For example, if a country produces cars, then it needs steel, rubber, parts, and oil to transport it all. All of these cost more when a country has a weak currency. It takes awhile for a company and it’s employees to feel the effects of a weak currency because many companies have long-term contracts for oil, steel, and other materials, or large stockpiles that were bought while their currency was still strong. By the time the company realizes that their costs are rising and something is fundamentally wrong, they no longer remember that the problem was caused by currency devaluation.
Here is a summary for those that didn’t follow: If a country has a weak currency, then it costs more to buy oil and raw materials, which are inevitably used to produce the products that are exported. So politicians want weak currencies because it makes the economy appear stronger in the short term as energy and commodity prices take a while to filter down into the price of products.
A declining currency can weigh on a country’s economy in a number of ways. First of all, a declining currency is bad for the stock market. Foreign investors shun stocks listed on an exchange of a country with a declining currency because they can lose as much or more money from the currency devaluation than they make on the stock appreciation. Plus, not all companies profit from a weak currency. Companies that don’t export products see their buying power decrease with no real benefit.
A weak currency also limits the ability of a nation’s citizens to buy foreign assets and to travel. At the end of the day, a country’s wealth is measured by what the citizens and the government can buy. If a country has a strong currency it can buy more products and assets i.e. land, business, and infrastructure from other nations. If a country’s exports are hurt by a strong currency, it should print more money to buy other countries’ exporting businesses. Either the currency will decrease in price because more has been printed, and therefore make the exports less expensive, or the country will own exporting businesses in other nations with weak currencies and therefore be hedged.
The most serious risk of devaluing a currency is the potential for hyper-inflation, as seen in Zimbabwe where a loaf of bread costs one trillion dollars. When a country’s currency is constantly declining, citizens will try to keep raising prices to stay ahead of the curve, which destroys the credibility of the currency.
The negative effects of a strong currency can be detrimental to one segment of the economy, the exporters. The positive effects however are felt by almost every citizen. The stock market gains value, citizens can buy property, businesses, and houses in other countries for less money. The potential risks for a country with a strong country are almost none; the only exception being that the exporting segment may have to become more efficient in order to compete. The risks of a declining currency on the other hand can range from a declining stock market and high resource costs to hyper-inflation that destroys the entire economy. Americans should be far more worried about China having a strong currency than a weak one. After all, if China’s Yuan appreciates, instead of China owning 10% of America’s assets, they will own 50%.