Thursday, September 16, 2010

Competitive Devaluation in Progress

Manipulation of a country’s currency is one mechanism that can be utilized to try to reflate economic growth. This is especially true when a country has a heavy reliance on exports. A cheaper currency lowers the cost of the country’s products abroad, thereby boosting the ability to export goods. When many countries are trying to weaken their currencies at once it is called competitive devaluation. This typically occurs in environments that have a deflationary tone; when there is too much supply and not enough aggregate demand in the global economy. That appears to be the backdrop in the world today, so it’s not surprising that a weaker currency is being pursued by many countries.

Yesterday, Japan’s currency intervention was a hot topic, and the yen weakened appreciably on the day. However, many believe it won’t work, primarily because it’s a unilateral move right now, and it’s hard to believe that other countries will have much tolerance for an appreciating currency versus the yen.

The U.S. is also part of this game, and today Treasury Secretary Timothy Geithner is again voicing concerns about the Chinese currency being artificially low. He’s done this before, and so far the Chinese seem to only get more adamant that they won’t be forced into a stronger currency. Listening to Geither rail against the Chinese currency policy, I wonder if the U.S. isn’t getting a dose of its own medicine from years past. In 1971, then-Treasury Secretary John Connolly told Europe that “the dollar is our currency but your problem.” China hasn’t been as blunt yet, but their actions and rhetoric so far seem to reflect a similar sentiment. Let’s hope this currency devaluation environment doesn’t lead to broader trade wars and tariffs. Competitive currency devaluations need to be monitored closely in today’s investing environment.