Hi Everyone
I’m fascinated by monetary policy, currency valuations, etc. But mostly ignorant.
I understand how a strong / weak dollar impacts imports and exports. I’m aware that Trump would like see the dollar weaker in order to improve exports.
My question is this: What happens to the global economy, interest rates, etc. if all the industrialized/major currencies try to weaken their currencies at the same time?
Exchange rates are ratios between two currencies.
If the USD:EUR exchange is 0.90 and the US and EU simultaneously and once off devalue against the other by 10% the exchange rate does not change.
So if these were the only currencies in the world there would be no net effect.
However if the exchange rates were being adjusted in a “they did, so we responded, so they responded, so we responded again” sort of way that would induce economic uncertainty, then bond prices would probably fall, interest rates rise and GDP contract.
You also have to look at the mechanisms by which governments seek to devalue. Exchange rates are not set by government diktat; if a government wants to devalue its currency on world markets (while maintaining it as a freely-traded currency) it has to do things like offer large amounts of its currency for sale, lower interest rates so that its currency is less attractive to people looking for a currency in which to save, etc, etc. And if governments are competitively engaging in such measures, then obviously that will have economic impacts.
To answer your own question, just look at the global economy over the past 11 years. When governments want to weaken their currencies, they adopt expansionary monetary policies. Basically, they lower their federal interest rate and start buying treasury notes in order to increase the money supply within country. Governments perform these actions not only to weaken their currencies, but also in response to economic downturns. During the 2007-2008 financial crisis, there was more-or-less global monetary expansion. There has been some minor tightening since, but overall monetary policy is still essentially loose.
Here’s a pretty good overview:
With the respect to the strength of the US$, during times of crisis: financial markets, terrorist events, war, etc. many global investors, even foreign governments, flock to the US$ in terms of their investments because of the stability. Most countries use the US$ as their reserve currency. This causes the value of the US$ to increase, and conversely most other currencies weaken or devalue relative to the US$.
If you were an opportunist, during time of crisis, when the US$ is rallying, you could invest in other currencies, and wait for the crisis to subside and the value of the US$ to fall as investors turn back to other currencies. Then sell your basket of foreign currencies, buy US$, voila PROFIT.
I was in France in 1969, when the French government devalued the franc (in those days there were gold standards and silver standards rather than “floating” currencies.) As a tourist on the border between France, Germany, and Switzerland I can tell you what happened to me. Some merchants in Germany and Switzerland wouldn’t take French francs at all; francs were suddenly worth about 20% less when I officially converted them into other currencies; and the price of stuff imported into France did not suddenly drop - rather, the price of French-made stuff went up.
A currency is just like wheat or oil or pork bellies - if there is more of it, the perceived value - how desirable it is and what people are willing to trade it for - goes down. The US government printed an extra hundred billion and handed it out to all citizens? Suddenly everything is going to cost a lot more. “Why should I work for $15/hr when you can easily afford to pay me twice that?” or “why should I charge $5 for a hamburger when you can afford to pay me $15, and the baker and rancher want more for their products?” Even if the extra money finds its way into the economy through plenty of very-low interest (desirable) loans, as the extra currency permeates the economy, prices will go up. Expanding the money supply is inflationary. If the EU, by contrast, does not print more currency - it will sell its Euros for more of the US dollars than it used to - i.e. a dollar isn’t worth as much vs. euros because there are too many dollars per euro.
Thanks for the info, and I will definitely check that link, Spanners.
Just to be clear, I understand what happens when a currency is devalued. My question is what happens if we have a race to the bottom… Or for that matter, if that ever happens.
When that happens we gethyperinflation. It’s happened on an international scale a couple of times. Germany-Austria-Poland in the early 1920s is probably the best race to the bottom example.
You had something close to that during the era of US vs Japan Inc. The Japanese were deliberately trying to undervalue the Yen to make exports more competitive. How they were doing it was a combination of monetary policy (your interest rates, money supply tweaks among others) and factual valuation, which is really how one RE-VALUES one’s forex vis-à-vis the $, as an example.