One of the features of the credit crunch era is that financial markets are meddled with and intervened in so much it is difficult to know what the “true” prices are. Of the main markets it is the currency ones that often give us the clearest clue I believe. This is not to say that there is no intervention here as for example the Swiss and their 1.20 cap versus the Euro prove that there is. Indeed you could argue that the creation of a currency zone such as the Euro is itself a type of intervention. But on the other side of the coin the enormous currency flows mean that even the largest attempts to intervene often fail. I worked in a merchant bank treasury department when the pound was forced out of the forerunner of the Euro called the ERM in 1992 and there was genuine shock at the Bank of England as what it considered to be large intervention was soaked up like a sponge. Also we have seen the Bank of Japan in the past try again and again to weaken the Yen and fail again and again.
The poor record of central banks in this area is a grim reminder of their fallibility and it is a constant source of surprise and bafflement to me that economists continue to persist with theories which have them as omnipresent and omniscient like some cartoon super-hero.
What is a winner and a loser?
Ordinarily it is assumed that the losers have currencies which are rising and the winners are those who have ones which are falling. Accordingly price competition will mean that the latter will see economic expansion and the former contraction as a result of the move meaning that like Hot Chocolate those with rising currencies will be singing.
So you win again, you win again
Here I stand again, the loser
This is the standard competitive devaluation model where the winners are perceived to be those who weaken their currencies. Except that the situation is far from that simple as for example my country the UK weakened its currency in 2007/08 by approximately a quarter but even now around five years later the improvements have been patchy. The Governor of the Bank of England has made himself something of a laughing stock by the use of the phrase “rebalancing” to describe this when in fact the impact was minor. Let one of his colleagues at the Bank of England Martin Weale describe what actually happened in a speech last month.
the balance of trade measured in current prices is now not much better than it was in 2008.
However Martin Weale in this same speech demonstrated that he too spends some time in la-la land as he feels that benefits may still arise from the 2007/08 devaluation. Indeed having observed the Chancellor of the Exchequer also trying to talk down the pound only yesterday the British establishment seems to be ridden with this view. Perhaps they hope that Tom Petty was right.
Baby even the losers
Get lucky sometimes
Also we need to consider that for the UK the situation has changed because the 1992 devaluation when she was ejected from the ERM was one where her economy then boomed and she “won” whereas by 2007/08 things were different and she lost as output went nowhere and inflation became an issue.
Okay so are the losers in fact winners?
If we move to the other side of the coin we see that some economies seem to have avoided the economic weakness that you might think would have been caused by the rise in their currency. For example whilst Japan had problems because of the rise of the Yen she in fact did surprisingly well when you consider that against the US Dollar she went from 110 Yen in the middle of 2008 to the mid-70s in 2011. So we see that perhaps the anti-inflationary effect of the currency rise helped to insulate her although it is also true that many Japanese exporters moved production elsewhere. As the Swiss Franc surged we also saw that whilst there were effects observable her economy maintained a forward momentum and grew overall. Of course unlike a test in a laboratory we have nothing to compare it too but whilst there were losses for these two it is not clear that they outright lost. If you compare them with the UK you can argue that Switzerland has performed better in spite what would be regarded as a strong currency disadvantage.
So we are left with the view that some production is price competitive but some is much less so and demand for it is what is called price inelastic. On this subject I have long thought that the whole concept of a demand curve as demonstrated by textbooks is misleading as from the limited number of points on the graph we can actually draw we simply do not have enough information to assume that. The UK’s experience proves that.
Is the Euro a winner or a loser then?
As we observe one of the largest efforts at currency manipulation in recent times the creation of a currency bloc incorporating much of Europe called the Euro there are many ways of looking at this. Firstly it was rather odd that the President of the European Central Bank quoted this from the recent G-20 meeting.
We reiterate our commitments to move more rapidly towards more market-determined exchange rate systems and exchange rate flexibility
Odd don’t you think as he owes his job to a system (the Euro) which relies on exactly the reverse? However he did point something out with which I can agree and I have put a bracket around the dodgy bit.
The nominal (and real) effective exchange rates continue to be in line with their long-term averages
The nominal effective or trade-weighted exchange rate for the Euro is virtually exactly at its 1999 or opening level (100.38 to be precise). I think we immediately learn something which is that some countries can cope with this much better than others. JP Morgan recently put it another way when it analysed what exchange rate various Euro countries needed versus the US Dollar and its estimates varied from 1.07 to 1.49. I will let you figure out the two extremes with one clue which is that they start with the same letter of the alphabet.
If we now look at recent events where the Euro has risen from 94.4 on the index quoted above since late July last year we can analyse the likely effects. It is quite possible that the German economic locomotive will power on with little effect but places where exports are price competitive are likely to see a hit. We know that the peripheral countries are much more likely to be affected by this and we also know this undermines the internal devaluations (wage cuts to you and I but hopefully also some increased productivity) that are Euro area policy for them.
But there is a catch which is illustrated by Germany. If there are no gains from a cheaper currency for a country like her why did she join the Euro. I am afraid that out of the goodness of her heart does not cut it for me! So she saw a gain in an exchange rate taking a lower path meaning that even she feels that there is a limit to how much of an appreciation she can take. Also there is the counterpoint which is that the others were implicitly accepting a higher exchange rate which I guess right now more than a few are ruing. I do not think we will lie awake at night wondering where the Drachma,Escudo,Lire or Peseta would be now relative to the Euro.
What about right here, right now?
Japan and the Yen
As I type this the Yen is plummeting again and has fallen to 95.5 Yen to the US Dollar. Indeed its fall has been so sharp it has even been falling in 2013 against the overwise weak pound which is now at 143.6 Yen. But so far the record of what has been the initial plank of the Japanese economic plan or Abenomics has disappointed somewhat. I am not discussing output or trade figures as their response will take time but the February inflation figures showed another fall. When you consider that the spot price of a barrel of Brent crude has risen by 10% in 2013 so far then an impact should be happening although again it may take time.
But what we will see is a battleground between price competition and a build-up of inflationary pressure. For all the analysis as important as anything was described by Kylie Minogue with her first hit.
I should be so lucky
Lucky lucky lucky
As for example a fall in the oil price and other commodities would come in nicely right now for this strategy.
Recently we have lost at this game as our tendency to inflation eroded any competitive gains. Frankly if we try it again I expect us to lose again.
The United States
For all the talk of currency debasement and monetary debasement such as the QE to infinity programme (85 billion US Dollars a month) the US Dollar has been rising recently. The trade-weighted dollar index (1997=100) is at 100.83 and is a couple of percentage points up on the beginning of February. So if the US authorities wish to reduce the value of the US Dollar they have work to do.
So there you have it. In my view the common concepts of winners and losers from conventional economic theory are as misleading as much of the rest of it has turned out to be. You have to look more deeply into individual economic circumstances to see whether a currency fall is good or not. Also it is clear that if some is good more may not be! You also need more than a soupcon of luck!
Also I note with a wry smile that as we churn around the subject of currencies and possible wars that both the US Dollar and Euro are close to unchanged on their nominal averages! Oh well you might say but of course there are plenty of other factors too such as inflation and productivity differences.