The perceived trade-off between export growth and currency strength is as widely held as was that of inflation and unemployment. The lackluster performance of Zimbabwean export industries in recent years should serve - as the stagflation of the 1970’s did - as one of many real world demonstrations that no such trade-off exists. Unfortunately, the Swiss National Bank has begun manipulating their currency in accordance with the policy prescriptions implied by this economic fallacy. It is important that Australians understand that ‘competitive devaluation’ is among the least economic behaviours imaginable.
The argument in favour of currency devaluation runs as follows. A strong currency drives manufacturers out of business due to a decline in both domestic and international demand resulting from the increased affordability of international markets relative to domestic markets. Therefore, the central bank should intervene to diminish the value of the currency. In the first place, this argument focuses only on immediate and short-run effects. And for that matter, it focuses on only some of the immediate and short-run effects. It ignores, for example, the fact that the cost of imported factors of production are immediately reduced. This invariably increases the international competitiveness of manufacturing firms.
It also ignores the mechanics of the price system and how it evolves over time. Exchange rates are among the most sensitive prices in the world. They fluctuate continually in response to changing market conditions and investors considerations of those conditions. Other prices in the market place respond to these changing conditions far less frequently and to a lesser degree. A stronger currency means cheaper input costs and this translates over time into lower prices throughout the market. A stronger currency means greater purchasing power for all users of that currency.
Ignoring these effects and misunderstanding the process by which the market reorients resources toward more urgently desired uses has caused many analysts to perceive a strong currency as a hindrance to economic behaviour. The reality is that through bankruptcy, the market makes the most of resources, which would otherwise have been squandered if the losses sustained by the business had been subsidized by government intervention. Salvaging resources in this way is essential to promoting the fulfillment of as wide a range of human needs as possible with the scarce resources available to us - the essence of the economic problem.
The fallacy becomes weaker still when the effects of currency devaluation are considered. By diminishing the value of the currency, the government can prop up the businesses which would otherwise have gone under. These are the effects which most analysts perceive. They do not understand that these are precisely the businesses which the market has determined should not be made guardians of scarce resources because of their inability to direct them toward the satisfaction of the most valued human needs. Propping these firms up only serves to reinforce their initial malinvestments.
Furthermore, artificial government support for these firms can only ever be temporary - which is good considering the harmful effects of enacting such support. But even from the point of view of proponents of currency devaluation, their own efforts are stifled by the dynamics of the market which they misunderstand. As the price structure shifts upward with the diminished value of the currency and the passage of time, firms face higher prices both domestically and internationally which reduce their competitiveness in foreign markets. This is now being seen in the US where exports have recently declined to their lowest level in over two and a half years despite the plunging value of the US dollar.
Many point toward China as the shining example of the success of currency manipulation. It is true that Chinese markets have engaged very much with international markets as a result of their manipulation. But the nature of this engagement has been thoroughly misunderstood. The goal of all economic action is a desirable allocation of resources. Manipulation of the Chinese renminbi has resulted in resources being directed away from Chinese citizens and toward the international markets with whom they engage. This leaves China with a whole lot of inflation and not a whole lot of anything else.
Those who call for ‘competitive devaluation’ misunderstand the market process. International competitiveness cannot be achieved by artificially debasing a currency. Such a process subsidizes uneconomical behaviour at the expense of economical behaviour. The winner of any such ‘competition’ will be rewarded with a currency that fails to operate, business conditions that cannot be described as economical by any measure and lower standards of living.