I have always been interested in international markets, which is one of the reasons I started studying economics at the University of Michigan. It is an extremely complex and dynamic issue, something that I still struggle to fully grasp, with many players involved, primarily central banks. The intent of the post is to shed some light on the role of central banks, why currency rates matter, and what it means for the everyday person like the reader, and myself, basically people without a Ph.D. in economics or finance.
It may seem like what is happening half way around the world in some bank doesn’t affect the day-to-day life of Americans but that is far from the truth. If you haven’t noticed it already start paying attention, but it seems that every clothing label, and nearly every product in the United States today has “Made in China” printed on it somewhere. But, why is that you may ask? To put it simply, it is because Chinese currency is cheap, making Chinese exports cheap, so we buy those goods.
The idea of a cheap currency seems bad intuitively, anything with the word “cheap” in it typically does. Luckily, Jacob Goldstein from NPR can shed some light on this issue of why a cheap currency is not necessarily a bad thing.
“… There’s a big upside to a weak dollar: It makes U.S. exports cheaper, which encourages people and businesses around the world to buy more of our stuff. Increasing exports is key to increasing U.S. economic growth without relying too heavily on domestic consumer spending” (Goldstein, 2011).
Although this quote is from the perspective of the United States Dollar the same logic applies if you were looking at it from the perspective of China, and the Chinese Yuan. When China maintains a weak Yuan, the goods they are producing and selling abroad appear very cheap. This allows companies in China to reach a new consumer base, which is why so many things in the U.S. seem to be made there. They can then rely on this new revenue stream to pay newly hired employees and increase production levels for the foreseeable future.
Now that you have learned that a weak currency can play a positive role in a nation’s economy, you might be thinking that every nation should deflate its currency. Well, that is actually what many places are doing, specifically in Europe, as a way of providing a feeling of economic security domestically, although there are some negative consequences.
“Denmark on Monday became the latest European country to cut its interest rates as it attempted to dampen investor interest in the Danish krone ahead of the European Central Bank’s policy meeting on Thursday” (Duxbury, Cox, 2015).
“Nationalbank’s main policy role is to maintain the stability of Denmark’s currency against the euro to provide stability for the nation’s exporters and keep inflation low and stable” (Duxbury, Cox, 2015).
An issue with Denmark devaluing their currency, or anyone for that matter, is other countries may try to do the same in order to counteract Denmark’s policy and maintain a stable economy at home.
“Neil Mellor, a strategist at BNY Mellon in London noted Sweden’s Riksbank talk about unconventional measures and also said he wouldn’t be surprised if Norway’s central bank, Norges Bank, is pressured into acting too” (Duxbury, Cox, 2015).
With the risk of at home inflation due to currency devaluation, it clearly is not the best action if nations engage in competitive policy to devalue their respective currencies.
“Devaluation can lead to a reduction in citizens’ standard of living as their purchasing power is reduced both when they buy imports and when they travel abroad” (Wikipedia.org, 2015).
Although I have painted a weakening currency in primarily a positive light, that is not always the case. A downward spiral of a nation’s citizens’ standard of living is a never a good thing, especially from the perspective of individual citizens. These negatives can become severe, especially if the battle between nations to weaken their currencies spirals out of control. Hopefully you have come away from this post with a greater interest for and understanding of international monetary policy, and how it affects the lives of every individual, even ones on the opposite side of the globe. Next time you are in the market for a low cost good, and it happens to be from China, you will understand why that is the case.
Duxbury, Charles, and Josie Cox. “Denmark Central Bank Cuts Rates.” WSJ. The Wall Street Journal, 19 Jan. 2015. Web. 19 Jan. 2015.
Goldstein, Jacob. “The Upside Of A Weak Dollar.” NPR. NPR, 29 Apr. 2011. Web. 19 Jan. 2015.
Wikipedia contributors. “Currency war.” Wikipedia, The Free Encyclopedia. Wikipedia, The Free Encyclopedia, 18 Jan. 2015. Web. 20 Jan. 2015.