logo
  Join        Login             Stock Quote

Mutually Assured Devaluation?

 January 28, 2013 02:58 PM


Central banks have taken on an ever-more activist role in enacting unconventional—and often misguided—policies over the past few years. Many folks see these actions as efforts by central banks to force down currency valuations relative to heavy trade partners, making exported goods cheaper and, hence, more attractive. In some corners, this is called the academic-sounding "competitive devaluation." Others use a more bellicose term: Currency Wars—and fear it as a form of trade war.

A very basic discussion of the theory underpinning competitive devaluation goes something like this:

  • GDP's calculation uses net exports (exports less imports).
  • Exports therefore buoy headline growth, while imports detract.
  • A weak currency relative to trading partners' can make exports more affordable to trading partners.
  • Currency valuations are often influenced heavily by relative interest rates—lower rates than major peers can mean a weaker currency.
  • Thus, by reducing relative interest rates or directly intervening in currency valuations, some suggest they're promoting growth.

[Related -Initial Jobless Claims Rose Unexpectedly]

Here's the problem—the theory starts from a fallacious point and ends with an equally fallacious point.

While we don't argue at all with the notion rising exports relative to imports results in a positive contribution to GDP, we would suggest this isn't directly equivalent to economic health. In fact, pursuing a policy targeting increased exports merely selects a favored portion of the economy, harming others. Case in point: Shinzo Abe's Japan.

[Related -All Quiet on the Record High Front]

Japan's Grover Cleveland won non-consecutive reelection largely on a platform of government intervention in the economy. One intervention Abe suggested was prodding the Bank of Japan (BoJ) to initiate further quantitative easing, with an end goal of weakening the yen. Abe seemingly believes Japanese exporters stand to benefit if the yen were weaker—causing Japan's exports to fall in price abroad. And the BoJ acceded, announcing a new, unlimited round of QE. And in the short term, the yen has fallen.

However, before hailing Abe's policy a success, consider: There's little real evidence an entire economy benefits from a cheap currency.

Assuming continued successes, Abe's quasi-mercantilist policy might help exporters, but it does precisely the opposite for importers—it makes foreign goods more expensive. In post-Fukushima Japan, much of the power generation is underpinned by liquefied natural gas and other imported sources. Those sources would be more expensive due to a weak yen, hampering economic growth, not fostering it. Further, many times the very exporters Abe seeks to aid were importers a step earlier along the global supply chain. Abe's narrow view theoretically and simplistically favors one group to the exclusion of others—a common macroeconomic error.

But that's just the start. The other often-forgotten point surrounding competitive devaluation seems to be the fact exchange rates move in pairs. The dollar, for example, has no absolute up-or-down tick. It ticks versus something in a market: yen, euro, krona, kiwi, loonie, basket of trade-weighted currencies, Bhutan's ngultrum. So one nation's actions alone aren't the only factor—meaning, assuming it's intended, one country's attempted devaluation can easily be countered.

Given how liquid and fungible currency markets actually are, there's no really consistent devaluation tool…or, we guess, weapon…to employ. Take the often-discussed current version—QE. Perhaps it occasionally influences the dollar's relative standing, but it's hard to discern any impact on others. For example, consider the Fed's actions over the past few years.

If you took the Fed's balance sheet expansion at face value, you might think Exhibit 1 would correspond to a consistently declining dollar versus a broad, trade-weighted basket of currencies. 

Exhibit 1: US Federal Reserve Balance Sheet

Source: Federal Reserve Bank of St. Louis.

And for a time, the dollar did fall after QE2 was announced in early November 2010 (though correlation doesn't necessarily mean causation). But it isn't as though the Fed stopped with QE2, subsequently announcing Operation Twist, QE3 and QE-Infinity. Yet, as Exhibit 2 shows, the dollar hasn't wiggled much in the wake of those moves—and in fact, it's since largely recouped the post-QE2 announcement decline and sits incrementally above where it began 2010.

Exhibit 2: US Dollar Vs. Trade-Weighted Currency Basket (Dollar Indexed to 100 at January 2010)

Source: Federal Reserve Bank of St. Louis. Basket includes euro currency, Canadian dollar, British pound, Swiss franc, Australian dollar, and Swedish krona. 01/01/2010 – 01/18/2013.

So in essence, while competitive devaluation may be a rather misguided goal some countries are pursuing, attaining it is far from assured. But even if they did, the results would likely be a combination of pluses and minuses. And assuming two countries compete for a weaker currency, the likely outcome isn't necessarily devaluation for all parties involved.

source: Market Minder
Disclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by Fisher Investments or performance of its clients. Such viewpoints may change at any time without notice. Nothin herein constitutes investment advice or a recommendation to buy or sell any security ot that any security, portfolio, transaction or strategy is suitable for any specific person. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
iOnTheMarket Premium
Advertisement

Advertisement


Post Comment -- Login is required to post message
Name:  
Alert for new comments:
Your email:
Your Website:
Title:
Comments:
 

rss feed

Latest Stories

article imageInitial Jobless Claims Rose Unexpectedly

Claims unexpectedly rose in the latest report through last weekend to breach 300,000 for the first time read on...

article imageAll Quiet on the Record High Front

What can we glean from the media’s lack of attention to the market’s recent record read on...

article imageThe Chip Maker Short Sellers Should Be Watching

Investing in semiconductor stocks is always tricky. Industry cycles can lead to bumps in the road for the read on...

article imageChicago Fed: US Economic Growth Slowed In October

The pace of US growth slowed more than expected in October, according to this morning’s update of the read on...

Advertisement
Popular Articles

Advertisement
Daily Sector Scan
Partner Center



Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.