How often does a devalued currency lead to cheap living?

Factual Questions
1

This is going to be a very basic thread, because I could pour all of my knowledge of economics into a sippy cup and still have enough room left for enough coffee to make a three-year-old bounce off the ceiling.

I remember going to Austria in the mid-1990s, years before the changeover to the Euro, and finding an exchange rate of roughly 10 schillings to the American dollar. I seem to recall everything being about ten times more expensive, more or less: They may as well have taken American prices and shifted the decimal point over a place. The ‘advantage’ of converting from a currency with smaller numbers printed on it was lost entirely.

However, I went to Canada in the early 2000s, before the Canadian dollar achieved near-parity with the American dollar, and things were substantially less expensive due to the exchange rate. (Yes, I do live Up North. No, I don’t go to Canada often. Going up there just to shop is a huge pain in the ass for multiple reasons.)

It’s possible I’m misremembering, but I don’t think so: As a limiting case, I doubt I could buy a good deal of Zimbabwe for thirty bucks American, no matter how many trillion Zimbabwean dollars that comes to. It’s all just numbers and goods get priced according to the numbers on the currency regardless of how many zeros need to be printed. Except in Canada it did have a distinct impact on my purchasing power, whereas in Austria it didn’t. (Yes, that was a confused sentence. I’m a confused person.)

2

I don’t quite follow you, but maybe I can help.

It just really depends. Often weak currency means that things that are locally produced (labor, produce, etc.) are cheaper but things that are imported are massively more expensive. In industrialized countries that manufacture their own stuff this means that you will see a difference in purchasing power for someone used to dollars. The same goes for strong currency. Stuff in England today is damned expensive for Americans, because everything is just shifted up a few notches.

But in unindustrialized countries it’s a totally different dynamic. I could live in West Africa on less than a dollar a day on local food, but I’ve seen supermarkets with ten dollar cans of ravioli and twenty dollar bags of frozen french fries. A four hour bus ride would only cost two bucks, but an ten hour train ride in none-too-comfy quarters costs the absurd sum of fifty dollars (in a place where most people lived on a dollar a day.)

In China most stuff is a lot cheaper. The exchange rate right now is like 6.8RMB per dollar. And in most cases you can think of one RMB as having the purchasing power of a dollar- A cheap noodle lunch might cost 5 RMB. A large beer costs 3 RMB. An overnight train ride costs 100 RMB. A new sweater might cost 30 RMB. But then there are random things that don’t mesh in with that- a tiny little bottle of Nescafe costs 20 RMB. A four hour bus ride costs 100 RMB. Dinner for one at Kentucky Fried Chicken costs 25 RMB. A cheap-o blender cost me 120 RMB.

3

This is a complex question, and I’m partially responding only to bump it in the hope that someone with more knowledge will provide an answer.

But essentially, if currency rates remain stable, then you could expect that the prime differences between countries would be due to local production costs and transportation issues. Look at even sven’s example of Africa: wages are rock bottom, so farm production is cheap, and so eating locally is cheap. But transportation is hideously expensive because the equipment is all foreign and the locals have little of value to trade for the transport, let alone for the goods themselves, and so canned food and bus tickets are ludicrously expensive, even by Western standards. But in a developed country like Austria, with similar technology levels and labor costs, those differences wouldn’t show up. Your experience would be expected: you just shift the decimal (or compensate for whatever the local rate is), and that pretty much settles the issue.

But exchange rates aren’t stable. Canada is a great example of that. The loonie lost a lot of value when they balanced their budget and started cutting their debt. This lowered interest rates because the government wasn’t crowding out private investment, and lower interest rates caused a decrease in international demand for their currency. So the loonie started to drop in value. In time, you’d expect that things in Canada would be comparatively more expensive, and we did see some of this, especially visible in the price of books. But again, that’s an international issue since books printed in the US can be shipped to sell in Canada for a higher price.

But local production wouldn’t increase in price so quickly. The prices for domestic goods and services would stay “sticky”, fixed, for quite a while. It takes some time for people to adjust to their gradually weakening currency, especially in an advanced country that can sustain itself and largely doesn’t need to rely on the rest of the world for its inputs. In this intervening time of price stickiness, foreigners could come in and do quite well buying domestic Canadian stuff. And this period of being able to take advantage of the exchange rate can continue for quite some time if the weakening of the currency is happening at a gradual enough basis that it doesn’t cause panic, but still consistently so that the local markets are always a step behind international markets.

I’m sure there’s a lot more to this, and I’m not aware of all the mechanisms, but essentially, what you were doing was taking advantage because of the change in currency rates, not the fact of the rates themselves.

4

Wonderful responses, everyone.

5

Very good answers to the question and they mesh with my experience living in Indonesia. Labor is cheap but anythin imported is crazy expensive. I can hire someone to paint my house for about $20, but my wife and I had lunch at a place that caters to expats using imported goods and it cost $16 for two sandwiches and a couple of sodas. A package of Oscar Meyer hot dogs is about $9, while some produce is so cheap that I couldn’t even tell you what it costs (it seems essentailly free to us).

6

FWIW the British pound has lost a quarter of its value against the dollar over the past six months.

7

This ties up with something I’ve been thinking about recently.

Obviously there is ‘commodity arbitrage’ so something portable should cost about the same wherever you are.

However there is something else I’ve noticed, things like the price of business hotel rooms and hookers tend to come in (say) 100s - basically nicely rounded sums that feel ‘right’.

There is something about 1 unit, 10 units, 100 units etc that establishes a psychological level of ‘value’. For example I’ve noticed that one EUR tends to buy about the same as one GBP - and it looks as if both get about the same as one USD.

8

Good responses so far.

Why is the currency devalued?

First, let’s distinguish between managed and floating exchange rates. Where the government controls the exchange rate below what would be its market value by selling its stock of official reserves of foreign currency, yes for a time, living can be cheap at least for a foreign visitor. It’s unlikely to be sustainable for all that long, since the stock of official reserves is limited and the operation of the central bank is compromised.

Under a market exchange rate, the exchange rate may be low due to some capital market panic or may seem low to foreigners due to purchasing power parity effects. Before turning to the latter - which is where I suspect the interest here really lies - let’s deal with locals.

A local who is fortunate enough to have assets denominated in foreign currency will do well from a low exchange rate. It’s not so much that living is cheap, more that they suddenly become richer. The vast majority of people whose income streams are denominated in local currency are poorer. How much poorer depends on how import-intensive their consumption bundle is. More expensive imports creep into the prices of domestically produced commodities where imports are used as intermediate goods.

Now, after all that, the answer to what I suspect is the real question: how come, when you visit some countries with market-determined exchange rates, does “everything” seem cheap (or expensive)?

This seems like a puzzle, because of what FRDE calls “commodity arbitrage” and economists call the law of one price. Because wheat sells on international markets, the price of bread should be the same everywhere* because if it weren’t you could risklessly profit from shipping wheat from one place to another.

This leads to the naive purchasing power parity idea: that because of the law of one price a US dollar should buy the same stuff everywhere and that if it doesn’t, market exchange rates are wrong and should be expected to adjust to make it so.

But market exchange rates are determined by trade, and not all goods are tradeable to the same degree. Wheat is very tradeable, haircuts aren’t - which is why economists make a point of getting haircuts in foreign countries. And, as Hellestal hints at, important things like transport, law enforcement, retail services etc, are sparsely traded. So purchasing power parity doesn’t hold, probably due to the Balassa-Samuelson effect.

So when you go to India, most things seem cheap. Bread is cheap even though the LOOP holds for wheat, there’s a lot of retail services in bread. When you go to Switzerland, most things seem expensive. And when exchange rates change rapidly, and for no obvious reason, and things seem cheap, your actions are part of the process that equilibrates exchange rates, but will not bring PPP into effect.

[sub]Don’t make me talk about real exchange rates or the Marshall-Lerner conditions.[/sub]

*[sub]abstracting from tariffs and transport costs, offer valid only in floating currency jurisdictions[/sub]

9

I can’t say anything general about the problem, but there are some special cases. Beirut has had rent control for years, so when the Lebanese Lira was devalued during the civil war, many people’s rent plummeted in real terms. I know people who today are living in large apartments for which they pay the equivalent in Lira of maybe $100 per month (in an area where the market value is $2000+). These days, rents are stated in US dollars to avoid this problem.

10

Purchasing-power Parity as measured through the Big Mac Index

11

Derleth, a specific case of what you are talking about has been taking place on the island of Ireland these last several months. Sterling, the currency in Northern Ireland, has lost value against the Euro, the currency in the Republic of Ireland. Also, the VAT rate in the UK has been cut to a lower percentage than in the Republic. Thus, for anyone living anywhere close to the border (which includes perhaps a majority of the population of the Republic) it has been worthwhile to go north to purchase goods. Pretty much ALL products are cheaper there because of the currency fluctuation. Many of the same brand stores have outlets north and south yet the price variation is substantial in many cases. Border towns, like Newry, Derry and Strabane have benefited enormously from the influx of Southern consumers. Over recent years, salaries have been typically higher south of the border than north too.

Here are some links:

http://archives.tcm.ie/businesspost/2008/07/06/story34291.asp

12

When I was in London in 2000, it was deceiving because the numbers in all the prices were similar to the ones back home in Canada: a KFC meal that cost 6.99 in Canada also cost 6.99 in London. However, the UK pound was worth 2.50 Canadian dollars at the time, so it was very easy to run out of money! I was startled to see that the UK pound is down to $1.80 Canadian (or the Canadian dollar has risen). Makes the UK significantly cheaper for me. The euro is still around $1.60 Canadian, though.

13

In my experience, devaluations lead to immediate price increases. When Brazil had hyperinflation (ca. 1995), the currency (cruziero0 was continually being devalued. Eventually, it was worth less than $0.0001. At that absurd point, the government introduced a new unit and the cruzeiro disappeared (along with people’s life savings).

14

For major countries, governments don’t have all that much control over the exchange rate. They can try to ‘talk up’ or ‘talk down’ a currency and they can (well once could) mess with exchange rates to encourage ‘hot money’ flows but neither is really control.

Basically the markets decide the exchange rates - in other words a bunch of hysterical FOREX traders working to make a buck on the day - not taking a ‘long view’ or even ‘a view’. I’m not talking about day traders here - I’m talking about major institutions and vast sums.

From my days studying economics (about 30 years ago) I remember puzzling over relative prices and exchange rates. I came to a woolly conclusion that the most immobile ‘goods’ is labour - and that devaluation was making ones domestic labour less expensive. For a heavily inflated economy (like prices have soared) devaluation is a ‘get out of jail quick’ card - devaluation is far pleasanter than wage deflation. Note, I said labour not land, as say, agricultural land is useless unless cultivated.

The thing that interests me is that governments, pundits and plonkers all seem to imagine that a ‘high’ or ‘strong’ currency is a good thing. Well it might be if your labour is skilled and highly productive as you have highly automated factories etc - but not all countries have the advantages of Germany and Japan.

Possibly having the sh*t bombed out of you and suffering a humiliating defeat is good for the national psyche - well it makes people work and invest in ‘real capital’ and ‘real infrastructure’ rather than …

I tend to define the current situation with currencies as one huge aircraft carrier (USD) with a load of minute ships firmly strapped to it - and a few medium sized boats EUR, JPY, GBP bobbing around next to it. In other words USD does not go down, the EUR rises or falls, but USD stays the same.

Not a comprehensive reply, but it is worth thinking about a few of those points. Also, despite studying economics, my subsequent experiences have made me rather contemptuous of academic theories concocted by people who have never prowled trading floors of major banks - or been in board meetings when investment decisions are made.