Advanced industrial nations across the globe are groping for ways to improve their economies amid record unemployment, slow economic growth and soaring deficits. The traditional dual Keynesian elixirs of fiscal and monetary stimuli have produced only tepid growth, coming at the cost of unprecedented deficits that are driving many nations toward insolvency.
Now, the world’s central economic planners have increasingly turned to outright money printing, often explicitly intending to devalue currencies and promote international competitiveness. Thus begins the first salvos of the burgeoning international currency war.
Central banks are ratcheting up monetary easing to promote the advantage that a cheap currency delivers to domestic manufacturing and international exports. For example, suppose the Mexican peso to American dollar exchange rate is 12 pesos per one dollar. If Mexico printed more pesos, the dollar to peso exchange rate would drop, so one dollar would buy, let’s say, 15 pesos. Since an American investor receives more pesos per dollar than previously, he is more inclined to open a factory in the cheaper currency market using his dollars.
Since that business can also produce cheaper products within a weaker currency, products sell at a lower price compared to a company operating in a stronger currency market. Therefore, a cheaper currency promotes exports while imports from a stronger currency zone become relatively more expensive. Nations with heavy reliance on trade and exports that lack a large domestic consumer base typically retain weak currencies. Meanwhile, large countries with robust domestic consumer power usually possess strong currencies that encourage importation of natural resources and raw goods needed for production.
However, even nations with large domestic consumer bases now look to devalue their currencies to gain export advantage, prompting other countries to retaliate.
Against the backdrop of years of deflation, astronomical debt and economic malaise, Japan has emerged leading the vanguard of the currency devaluation warriors. In order to create inflation, and supposedly growth, incoming Prime Minister Shinzo Abe swore to devalue the yen to prod spending and consumer demand.
However, the subsurface rationale of devaluation is the promotion of export competitiveness of Japan’s products, especially after suffering its first trade deficit in three decades in 2012. In reaction to Abe’s threats to end the political independent of the Bank of Japan, the yen has fallen 18 percent against the dollar since Abe’s electoral victory.
Other nations are following suit. Even before Japan’s actions, Switzerland pegged its strengthening franc to the euro to stem its emergence as a monetary safe haven in the wake of the Eurozone debacle. Hungary’s forint fell after its government instituted policies designed to curb the independence of the central bank, while Britain’s pound has fallen after news of further monetary easing plans. Meanwhile, the French Industry Minister railed against obstinate German central bankers and advocated a policy of euro devaluation in order to promote exports.
Of course, the world’s greatest currency debaser is closer to home—the U.S. Federal Reserve. Since 2008, the Fed has bought over $3 trillion of government bonds and mortgage-backed securities. While not explicitly identifying the objective for these asset purchases as to promote the dollar’s competitiveness, the Fed’s injection of monetary liquidity into the economy uses the same methods as the banks of Japan, England and others who specifically identify devaluation as a policy goal.
This growing currency devaluation battle will stunt economies around the world as retaliatory devaluation crimps international trade and curbs exports.
Ultimately, competitive currency devaluation produces the same results as protective tariffs, raising the cost of imports while promoting domestic industry. The world’s most destructive tariff war began after the passage of the Smoot-Hawley Act in 1930, which set off a cascade of retaliatory tariffs that plummeted international trade and deepened the onset of the Great Depression.
Secondly, devaluation increases the price of imports, including oil, therefore hurting industries and consumers reliant on foreign manufactures or raw materials. Devaluation also allows profligate governments to unload their debt onto the citizens in the guise of inflation. After Britain left the gold standard in 1931, the pound plummeted by 30 percent, effectively leading to the monetization of a third of the national debt at the expense of consumers’ purchasing power. A similar scenario now looks to play out in a dozen countries with crushing debt loads and faltering economies.
Finally, devalued currencies and monetary easing often promote, along with inflation, speculative foreign loans that lead to crash-prone and overpriced bubbles in real estate or industries, one of the major imbalances in many rapidly growing but unstable emerging economies.
Instead of devaluation, a wiser and more sustainable method to buoy economic growth is through tax and regulatory reform combined with the release of the massive amount of capital now sunken into government debt via restrained public spending and deficit reduction. Until those prerequisites are met, economic turbulence and monetary tribulations will continue.