Currency Wars Are Evil

Real people may die when countries engage in “currency wars.” Countries debasing their currencies risk, amongst others:

• Social unrest
• Loss of competitiveness
• War

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 strong 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.

Social Unrest

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 percent 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.