There's a theory that currency depreciation is good for you. The fall of the US dollar on world markets is welcomed by those who think a cheaper dollar will mean cheaper American exports and raise the cost of imports. The result: more American business abroad; fewer imports on the American market; a lower deficit and so on.
The corollary of this theory is that a strong currency is harmful to an economy. If the currency rises in value relative to others, products are priced out of export markets and imports increase. The first part of this theory is current in weaker currency nations, such as the United States, Britain, Australia, Denmark, France and elsewhere. Its corollary is general in such harder currency nations as Germany, Switzerland and Japan.
Like so many economic theories that form government policies, this one is working, right at the moment. Had it been when the pound sterling fell from $2.00 in March 1976 to $1.60 in early 1977, British exports would have risen, imports declined and its trade deficit shrunk. Similarly, Switzerland's Germany's, and Japan's trade deficits would all have risen as their products were forced out of world markets, or the strength of their currencies would have been checked.
What actually happened? Swiss exports rose a record 11 percent in 1977, a year in which the Swiss franc gained 22 percent on the dollar, and in the month of November, Switzerland recorded its first ever trade surplus.* The size of Japan's surplus increased in 1977 and Germany's remained roughly the same in 1977 as 1976. Britain has seen its trade deficit drop due to North Sea oil, not the devalued pound.
Naturally, changes in currency values have not been without effects on international trade. Because the Deutschmark has risen against the dollar, Volkswagen has had to substantially increase prices in the United States. Its market share has fallen for this and other reasons. But that was a problem for Volkswagen, not the German economy. Similarly, when the pound fell, thousands of Europeans and Americans flocked to London taking advantage of the travel and shopping bargains. When the Mexican peso plunged against the US dollar, the number of Mexicans who crossed the border to purchase their groceries plunged too, creating problems for a number of American border towns. Thus, changing currency values alter the underlying pattern but do not result in the weak becoming strong and the strong becoming weak.
This theory arose under the Bretton-Woods fixed currency agreement. When a government could no longer support its currency at the agreed, fixed price, it was allowed to devalue. When it devalued, exports rose, imports fell, the deficit dropped and all was well once again. Temporarily at any rate. The government had to devalue because it had been inflating its currency at a higher rate than the rest of the world. Devaluation worked, then, because bulk of the western world was not following wildly inflationary policies.
Thus, although the theory is economically accurate, it no longer works as it used to. For a start, the prices of German and Japanese cars have been rising in the United States. But then, so have the prices of American-made cars. When the pound falls, British products may become cheaper in German marks, but as internal British prices have been rising faster than domestic German ones, the pound's drop may do little more than compensate for the difference in changing price levels.
The primary reason the pound falls or the Swiss franc rises is that the government of England is increasing the supply of pounds faster than the government of Switzerland is printing francs. It's a simple case of supply and demand. But more factors are involved when considering currency relativities. For example, when the pound fell, theoretically giving Britain a price advantage over Switzerland in the European Economic Community, Europeans continued to buy Swiss. The Swiss might be more expensive, but they deliver higher quality products on time. Price, after all, is only one consideration in the buyer's mind.
One factor which has been completely ignored is the effects of inflation. The Swiss businessman does all his calculations in a stable currency. Unlike his American or British counterpart, his profits are not overstated because of inflation and he does not, therefore, pay taxes on grossly exaggerated profits. His real costs are lower and what's more they are predictable. The hidden costs of inflation cannot be underestimated—as Mises, Hayek, Rothbard and others have all pointed out. Those costs are significantly less onerous on the Swiss, Germans, and Japanese.
Also, associated with inflationary government policies is widespread government intervention. Like taxation, intervention substantially raises the cost of doing business, and thus the prices products must be sold at have to be considerably higher than those produced in countries with lower levels of government intervention, taxation and inflation.
In sum, countries with strong currencies will expand their trade at the expense of weaker currency nations. As governments still intervene widely to support their monies, this trend will be exaggerated. The German and Japanese governments intervene by buying dollars to keep their currencies from rising. (One result is to prevent the dollar from falling.) Thus Japanese and German products are kept relatively under-priced—and American products relatively overpriced. This trade effect of inflation multiplies the natural tendency for inflation ridden currencies to sink against their stronger partners.
Devaluing a currency is no longer a panacea. A weak economy begets a weak currency, and a strong currency is impossible unless the economy behind it is strong; which means: relatively free. So long as a country is ridden with inflation, intervention and taxation, its currency is bound to fall. And betting on the strong money will be a safe bet until the governments of weaker nations reform.
*I.e., excess of exports over imports. Switzerland has historically run a trade deficit, importing more goods than it exports. The deficit has been paid by "invisible earnings": banking services, insurance, and so on.
This article originally appeared in print under the headline "Money: The Strong Get Stronger".