Devaluation is Not the Answer

by | Apr 11, 2001

In the past few months, I’ve noticed a disturbing shift in attitude towards currency devaluation. An increasing number of economists and journalists are making comments approving currency devaluation as a way to boost economies and “gain competitiveness.” Some analysts, like The New York Times‘ Paul Krugman, have been recommending devaluation around the world for years, […]

In the past few months, I’ve noticed a disturbing shift in attitude towards currency devaluation. An increasing number of economists and journalists are making comments approving currency devaluation as a way to boost economies and “gain competitiveness.” Some analysts, like The New York Times‘ Paul Krugman, have been recommending devaluation around the world for years, and it seems that an increasing number are jumping on his bandwagon. Now, policymakers may be starting to accept devaluation as an economically good thing, posing a potential risk to investors and the world economy.

Recently, a Bloomberg journalist wrote a story about how Brazilian autoworkers are more “competitive” than Argentine workers, suggesting that this has proven the merit of Brazil’s ongoing currency weakness. But this “competitiveness” has come entirely from the fact that Brazilian workers have seen their wages cut in terms of global purchasing power – giving them 25% less than their Argentine counterparts. Other articles in favor of depreciation have emphasized the need for Korea to keep its currency “competitive” with Japan’s, for Argentina to catch up to Brazil, for Japan to end deflation, or for China to boost its exports.

With many countries now facing an economic slowdown, some are trying to find ways to offset a decline in exports. In the past, countries would turn to higher tariffs or import bans, combined with export stimulation, to deal with this. But these damaging policies have been effectively limited by the WTO. Unfortunately, for countries seeking a trade “advantage,” they often see currency devaluation as the only good policy alternative.

From the beginning of 2001 through April 6th, the Japanese yen has declined 8% relative to the dollar. A direct economic competitor, South Korea, has seen its won fall nearly 6%. Brazil’s real has fallen 9%. Not major devaluations, but these are large economies, sure to put pressure on the administrations of countries like Malaysia, Thailand, China, Chile, and Argentina. So far, these currency declines have not caused much worry. It’ s the attitude that is more worrisome.

Devaluation is a dangerous and destructive game. Though favored by the IMF, and other ivory tower economists divorced from economic reality, devaluation harms economies.

Remember the Asian Crisis? Few remember that the Thai market actually surged just after the Baht devalued. Government officials initially heralded the devaluation as a positive move and the IMF stupidly reinforced the thinking. Economists praised the “J-curve effect”, meaning that after a quick economic dip, newfound competitiveness would bring strong economic growth. It sounded so good that many other Asian countries followed, and neither investors nor economists were able to predict the economic disaster that would come as a result of devaluation.

The fact is, most people are hurt by devaluation. Inflation and interest rates tend to climb while the economy slows, and uncertainty confuses economic decision-making.

Some devaluation proponents naively claim that exporters will benefit extensively from the increased competitiveness coming from local currency costs and foreign currency revenues. But consider that many net exporters have seen their shipments decline in dollar terms after devaluation, due to trade turmoil and lower prices. For most companies, operating and financing costs will rise due to devaluation-created inflation, stealing back any initial competitive gains.

The purpose of a currency is to serve as a facilitator of exchange and a store of value over time. A currency whose value swings wildly does not facilitate a people’s ability to make long term economic plans, produce goods, calculate profits and losses, or save for the future-all foundations of economic growth. The only good currency policy is one that creates a solid foundation for future price stability. If a country is looking for a novel currency policy that will give it a competitive advantage, it should look to a gold standard, not devaluation.

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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