Currency depreciation is a fall in the value of a currency in terms of its exchange rate
versus other currencies.1 Some say, that this phenomenon is good for the economy, others
say, that it’s not.
Those, who say it’s good, claim that appreciation, the rise in the value of a currency, is bad
for GDP and exports.
From this results that depreciation should be good both for GDP and exports.2 But is
it really?
Rise in the value of one currency, with the other currency maintaining its value, must
cause depreciation of the first currency.
Periodic exchange rate fluctuations are perfectly normal market phenomenon, just like periodic
fluctuations of every market price.
The problem begins, when a given currency loses its value versus various other currencies
in a long term.
A core cause of this state of affairs is: demand for a currency on one hand, and the
supply of the currency on the other.
So, if the currency depreciates, there can be only two fundamental causes.
From the demand side, there is no interest in buying given currency.
Something makes this currency unattractive and makes people prefer other currencies.
The reason currency may be unattractive is a fear of inflation, bad investment environment,
a threat to property law, unclear politics, war and so on.
Let us assume that a foreign investor plans a big investment in a particular country.
To buy buildings, machines, to hire workers and to pay them, he must exchange his currency
to a local currency of the country he wants to invest in.
If he were to see, that conditions in this country are uncertain, the law is unstable,
war is coming or the government announces that it will confiscate property, he won’t
invest there.
It’s similar with the stock market investments.
The people that don’t want to buy given currency, then lower the demand.
From the supply side, either more people want to get rid of the currency, or its supply
rises due to its creation in the banking system.
Both situations can occur simultaneously.
The reason for people to want to get rid of their currency can be (although it doesn’t
have to be) its excessive creation, and as a consequence, high inflation.
Money creation depends mainly on the actions of central banks, but the reasons for getting
rid of the currency can be different.
For example, in times of economic turmoil, investors often seek to preserve value and
flee to so called safe-haven currencies.
One of the currencies considered to be safe-haven currency is Swiss Francs.1 In this case investors
sell their assets denominated in other currencies and buy Swiss Franc’s.
Also any strong uneasiness in a given country, high inflation, high law volatility, lack
of respect for property or any other systemic uncertainty, will cause people to get rid
of the currency.
Supposedly the main advantage of depreciation is that it props up exports.
Intuitively, this claim can seem true: If the value of a currency falls, prices of exported
products become more competitive.
Domestic exporters gain from this, and in consequence the whole economy is better off.
This kind of thinking doesn’t include a few important matters.
First of all: export is not the goal in and of itself.
People export goods to other countries not because they like to collect foreign currency,
but because they are then able to buy – or import!
- something from abroad.
Weak currency doesn’t help with that.
Look at in this way: when our currency is weaker, we must spend more units of our currency
to buy something from abroad.
This “something” was cheaper before.
Can paying higher prices for imported goods really be described as a prosperity growth?
Secondly, a huge part of exported goods requires the import of raw materials or semi-finished
products.
For example, if a car company wants to construct and export cars, first it needs to import
some of the parts from foreign suppliers, and their price in domestic currency would
be higher, if domestic is weaker.
As we can see, claims that “weak currency is good for exports” is – in the best
case scenario – a big simplification, and in the worst case scenario, a mistake.
As we’ve mentioned, weak currency makes imports more expensive.
But what are the further consequences of this fact?
Currency depreciation is destructive mainly for investments.
Let’s take the US import structure.
USA imports more than it exports.1 As we see, capital goods with industrial goods together
make the biggest group of imported goods.
At the same without these, investments and business development would be delayed, or
even forsaken.
Efforts to marginalize this problem of rising import costs - such as saying that “we won’t
buy luxury stuff from abroad, and buy more domestic brands” - are just wishful thinking.
Global economy is a system of strongly connected vessels.
Weak currency may cause those supposed gains from higher exports to be at least partially
eliminated by higher prices of raw materials and semi-finished products.
But that’s not all: more expensive imports would also cause the prices in stores to go
up.
Producers all over the world are struggling with prices of materials caused by the broken
supply chains – currency depreciation would only magnify this problem.
Surge in production costs would cause a surge in prices of final products.
In short, currency depreciation would put another brick in the wall of rising price
inflation, which affects most of the developed countries now.
Finally: depreciation of a currency may influence foreign debt levels and debt service costs.
If a private individual or a state take out a debt in foreign currency, depreciation of
domestic currency will cause the debt and interests to rise in the domestic currency.
To sum up, currency depreciation brings relative impoverishment for the society, which must
pay much more for products from abroad.
Because a huge part of exports requires previous imports, gains for exporters may be limited.
There are also other negative consequences such as a surge in the cost of production,
bigger foreign debt and price rises.
Let us add, that weak or strong currency is a market signal, when left alone.
And it’s good to have real information from real prices and exchange rates.
The right conclusion from this video is not that we should make our currencies artificially
strong when they are weak, but that intentionally making our currencies weak doesn’t in fact
achieve goal of “helping exporters” (although some exporters may gain from this) and additionally
causes other problems for the whole society.