Real people may die when countries engage in “currency wars.” Countries debasing their currencies risk, amongst others:
- Loss of competitiveness
- Social unrest
We discuss not only why we believe currency wars are evil, but also what investors may be able to do about them.
Loss of competitiveness
The illusory benefit of a weaker currency is to boost corporate earnings as companies increase their exports. That may well be true for the next quarterly earnings report, but ignores that their competitive position may be weakening. The clearest evidence of this is the increased vulnerability to takeovers from abroad. As the value of the U.S. dollar has been eroding, for example, Chinese companies are increasingly buying U.S. assets. The U.S. is selling its family silver in an effort to support consumption.
Importantly, when a country subsidizes one’s exports with an artificially weak currency, businesses lack an incentive to innovate. Japan is the best example: Japan’s problem is not that of a weak currency, but a lack of innovation. By weakening the yen, companies are given a free ride, taking an incentive away to engage in reform. Advanced economies, in our humble opinion, cannot compete on price, but must compete on value. European companies have long learned this, as there are rather few low-end consumer goods being exported from Germany. The Chinese have also heeded this lesson, allowing low-end industries to fail and relocate to Vietnam or other lower cost countries: China is rapidly moving up the value chain in goods and services produced. Incidentally, Vietnam has repeatedly engaged in currency devaluation, as the country mostly competes on price; in the absence of a strong consumer recovery in the U.S., we see further currency debasements in Vietnam.
In summary, market pressure to innovate is the most powerful motivation. Governments subsidizing ailing industries through currency debasement do long-term harm to their economies.
Currency debasement is not just bad for the corporate world: it’s particularly painful for citizens. Just ask citizens of Venezuela where the government just announced a 32% devaluation in the bolívar’s official exchange rate to the dollar. An overnight move of that magnitude is immediately noticeable, as are the negative effects on consumers, whereas gradual debasement in currencies of advanced economies are less noticeable, but ultimately have the same effect. The natural consequence of currency debasement is inflation, i.e., loss of real purchasing power; the two forces meet at the gas pump: As a currency loses value, commodities — all else equal — become pricier when valued in that currency.
Stagnant real wages in the U.S. over the past decade may in large part be attributed to the gradual debasement of the greenback, courtesy of fiscal and monetary policy. Folks whose real wages didn’t go anywhere for a decade feel cheated and are more likely to vote for populist politicians promising change. Currency debasement fosters growing income and wealth inequality and diverging political reactions, e.g., the Tea Party movement on the political right and the Occupy Wall Street movement on the political left. The rise of populism can be seen in the rise of Twitter: We sometimes quip that politicians that can distill their political message into a tweet have a better chance of being elected these days. Except that we are wrong: It’s not a joke.
In the Middle East, similar trends cause revolutions. People can be suppressed for a long time, but if they can’t feed themselves, they revolt. In the U.S., we are told food and energy is to be excluded from measuring inflation, as our economy is less and less dependent on food and energy (although curious that a record number of Americans used food stamps last year). However, in countries where large segments of the population cannot earn enough to feed themselves, currency debasement contributes to revolutions, not just the rise of populism.