Currency War: Facts And Myths

by: Lok Sang Ho

I just read this article by Francesco Guerrera of The Wall Street Journal. He quoted one senior Federal Reserve official as having said that "Devaluing a currency is like peeing in bed. It feels good at first, but pretty soon it becomes a real mess." I have no clue who said this, but there is simply no evidence that devaluing an over-valued currency causes a real mess. My definition of over-valuation is when the currency is so strong that the economy cannot achieve full employment except through running increasing fiscal deficits. That pretty much describes the case of Japan in the past twenty years.

The British sterling depreciated significantly in September 1992 after George Soros deemed the prevailing exchange rate too high to be sustainable. By January 1993 the British unemployment rate peaked, and then started years of decline, so that Britain became the envy of Europe, with the unemployment rate falling well below 5% by 2003.

Commentators talked of the messy effects of competitive depreciation in the 1930s. I just checked the figures of total industrial production 1927 to 1935 from this website. Table 2 in that article shows that Britain, the country that depreciated its currency first in 1931, began to see recovery in its industrial production in the following year. Industrial production hit bottom for France, Germany, Italy, Sweden and the U.S. in 1932 from thence all the economies kept rebounding. What is the mess? Where is the mess? Who suffered as a result of Britain's initiating the "currency war"?

People also refer to competitive devaluations following the Asian Financial Crisis. Yes, many countries in Asia-- with the notable exception of China-- devalued their currencies. But the devaluations did not lead to any "real mess" as far as I can see. Will anyone present any evidence that the "beggar thy neighbor policies" caused the regional economies to suffer economically?

It is true that if all currencies try to devalue, any beneficial effects from devaluation would disappear because all currencies cannot devalue. But this is an extreme scenario that is typically not quite relevant in the real world. After the Plaza Accord, the U.S. currency depreciated significantly against both the Yen and the DM. There was no mess. Instead, we saw the U.S. economy enjoy a decade of growth and shrinking fiscal deficit.

Once again, following an earlier claim, I propose that real currency wars take the form of forcing a country to appreciate its currency to levels that ruin its economy. Japan was a victim of such a currency war, and it is doing the right thing by letting its currency find a level that allows the economy to recover.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.