Currency Wars: Pandering to Debase
Tim Edwards, senior director of Index Investment Strategy at S&P Dow Jones Indices has been closely following the currency war that have been playing out round the globe, he looks at the pros and cons of debasing a country’s currency.
So far this year, we have seen a ravenous interest from US investors in currency-hedged equity exposure. Currency risks have increased; currency volatility is on the up:
The reasons behind these trends can be understood in part via the nature of human psychology and power, and the reality of politics.
Consider yourself, for a brief moment, the ruler of a mid-ranking economy; the proud nation of Atlantis. As in many parts of the world, your ministers, media and constituents are lamenting a series of profligate governments. Mounting government and consumer debts are handicapping your hopes of Keynesian stimulus. Meanwhile, international economic agencies besmirch your national pride: your labour force is “uncompetitive”; they and your social policies are at chiefly fault for your stuttering, moribund economy.
The choices are difficult. You might impose drastic cuts in government services and raise taxes to “balance the books”, no doubt at the risk of further constraining the economy. Or you could heed those plaintive calls from the IMF and drastically reform the marketplace for labour and businesses, reforming the tax code along the way for good measure.
Both options may engender significant opposition from vested interests to whom you are grateful for your position in power. More certainly, such measures will cause abundant and vocal distress in the population.
I’m a politician – give me an easier option!
But what if you could simply debase your currency? If the rest of the world is prepared to pay one US Dollar for what is currently worth three of your Atlantan Mickles, how much more competitive would you be if you could sell the same thing for $0.50? The answer seems obvious. Lower your interest rates! Print money! Your currency will soon be worth nothing!
Having a less valuable currency might dent national pride, but there’s plenty to compensate. Bond investors will benefit from falling yields; equity investors will celebrate your stimulus. And remember those large debts? They are suddenly cheaper (in USD terms) to repay and your low-low interest rates mean that everyone’s debt just got easier to service. Everyone’s a winner in Atlantis