Is a strong currency a sign of a strong economy? Are we overlooking the risks of a strong currency?

1.   If currency starts appreciating too fast, foreigners will start buying local stocks or bonds not because they believe in the economy, but because they believe the rising currency will increase the US dollar value of those investments.  

2.  For a while this bet is self-fulfilling, as foreign money continues to drive up the value of the local currency.

3.  Eventually, though, an expensive currency makes the country's exports too pricey to compete in global markets.  

4.  The economy stalls, the currency crashes, and the country will be poised to grow only when it stabilizes again, at a competitive value.  

Summary

A cheap currency is good.  A currency that makes local prices feel affordable will draw money into the economy through exports, tourism and other channels.

An overpriced currency will encourage both locals and foreigners to move money out of the country, eventually sapping economic growth.

Successful nations feel cheap, at least to foreign visitors.  (The cars of some developed countries are so cheap relative to those of Malaysia.  The food and personal wears of some developed countries are so cheap relative to their incomes and also for visiting Malaysians too.)

From Fixed--Exchange System to Free Floating Currencies

Bretton Woods Conference (end of World War 2)

One of the major accomplishments of the Bretton Woods Conference was the plan to link virtually all the world's major currencies to the U.S. dollar in a sort of fixed-exchange system, with the dollar serving as an anchor to global economic activity  

The value of the dollar, in turn, would be linked o a fixed amount of gold - one ounce for every thirty five dollars.

The Bretton Woods system allowed countries from Japan to Germany and from France to Brazil to grow and prosper.  But when the U.S. began running huge deficits - printing enormous sums of money to pay for everything from Asian wars to Great Society antipoverty programs - the rest of the world began to lose confidence

Abandoning the Gold Standard

In late 1960s, France began losing confidence in the system and started asking for the actual gold that had been backing up the U.S. dollar, and other nations followed the example.  Soon, more than half of the U.S. gold reserves had been transferred abroad.

The American government decided that the only solution was to abandon the gold standard.  From 1971 onward, the U.S. dollar and virtually all currencies in the world  became fiat currencies, backed by nothing than the faith of the people using them.

From that moment on the Bretton Woods system of fixed exchange rates was transformed into a system of freely floating currencies, with their values determined by the foreign exchange markets.

 

To anticipate a currency crisis or recovery, follow the locals

The feel of the currency is the simplest real-time measure of how effectively a country can compete for international trade and investment.

"The currency feels too expensive"

If a currency feels too expensive, a large and sustained increase in the current account deficit can result, and money will start to flow out of the country.  

The longer and faster a current account deficit expands, the more risk there is of an economic slowdown and a financial crisis.  

Traditionally, that warning light flashed when the current account deficit had been growing at an average rate of 5% of GDP for five years.  

But the recent deglobalization of banking has made it more difficult to finance current account deficits, so the new red line may be around 3%.

Beginning or the end of currency trouble, follow the locals

To spot the beginning or the end of currency trouble, follow the locals.  They are the first to know when a nation is in crisis or recovery, and they will be the first to move.  If the local millionaires are fleeing, so should you.

Once a crisis begins, watch for the current account to bounce back to surplus, which usually means that a cheap currency is drawing money back into the country.  It helps if the financial environment is stable, underpinned by low expectations of inflation, which further encourages investors to return.

Meddling by the government to artificially cheapen the currency

If the government tries to artificially cheapen the currency, markets are likely to punish this meddling, particularly if the country has substantial foreign debt or does not manufacture exports that can benefit from a devaluation.  

Cheap is good only if the market, not the government, determines the feel of a currency.

You Can't Devalue Your Way to Prosperity

A cheap currency is an advantage in global competition.  It might seem smart for national leaders just to devalue the currency.  But this is a form of state meddling that has proved increasingly ineffective.

Since the crisis of 2008, many nations have tried to improve their competitive position by devaluing currencies, but none have managed to gain an advantage.

The central banks of the United States, Japan, Britain and the Eurozone have pursued policies that effectively amount to printing money, in part as a way to devalue their currencies.  But each has achieved at best a brief gain in export share, because rivals quickly match each other's policies.

The rise in 2016 of Donald Trump, who keeps a hawkish watch on the moves of foreign central banks, made it increasingly difficult for any nation to devalue its currency without being called to account for it.

By 2019, many emerging countries had seen sharp currency depreciation, but with little boost to growth.  

• One reason was foreign debt; since 1996, in the emerging world, the debt owed by private companies to foreign lenders had more than doubled as a share of GDP, reaching 20% or more in Taiwan, Peru, South Africa, Russia, Brazil and Turkey.   For these countries, devaluation made it more expensive for private companies to service foreign debt, and forced them to spend less on hiring workers or investing in new equipment.

• Another factor that can derail devaluations is heavy dependence on imported food and energy.  In this case, a cheaper currency will make it more expensive to import these staples, driving up inflation, further undermining the currency and encouraging capital flight.  This is a recurring syndrome in nations like Turkey, which imports all its oil, but the problem is spreading.

• These days, even manufacturing powers are mere cogs in a global supply chain, relying heavily on imported parts and materials.  They thus find it harder to capitalize on a cheap currency because devaluation raises the prices they pay for those parts and materials.

A rare occasion when devaluation worked

China, in 1993, was one of the rare devaluations that worked.  

China had little foreign debt, it did not rely too heavily on imported goods, and its already strong manufacturing sector grew faster after Beijing devalued the renminbi.  

But this was an exception that proves the rule in general you cannot devalue your way to prosperity.

Devaluation is increasingly less likely to work

Moreover, devaluation is increasingly less likely to work, even in China, which has grown to command 13% of global exports, the largest share any economy has reached in recent decades.  It is just simply too big to expand much further and if it does devalue, others retaliate.  

In late 2015, China devalued the renminbi by 3%, and many emerging nations responded immediately, erasing any competitive gain that Beijing hoped to achieve.

China is also making increasingly advanced exports, which are less price sensitive and gain less from a cheap currency.  

In Korea, Taiwan, and China, technology and capital goods make up a rising share of exports.  

The more advanced the economy, the less of a boost it gets from devaluations.

George Soros warns China of global 'currency war'

George Soros has warned that a global “currency war” pitting China versus the rest of the world could lead to the collapse of the world economy.

By Rupert Neate
Published: 3:01PM BST 09 Oct 2010



Mr Soros, the hedge fund manager best known as the man who broke the Bank of England” after he made a billion betting against the value of Sterling on Black Wednesday in 1992, said the China had created a “lopsided currency” system.

He criticised China for deliberately keeping the yuan - its currency -low in order to keep exports cheap, which is hurting US competitors.


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Mr Soros told BBC Radio 4’s Today programme that China had a “huge advantage” over international competitors because it can control the value of its currency.

He said China could also influence the value of other world currencies because they have a “chronic trade surplus”, which means the Chinese have a lot of foreign currencies. “They control not only their own currency but actually the entire global currency system,” he said.

Writing in the Financial Times, Mr Soros added: “Whether it realizes it or not, China has emerged as a leader of the world. If it fails to live up to the responsibilities of leadership, the global currency system is liable to break down and take the global economy with it.”

China’s central bank governor Zhou Xiaochuan defended the world’s second largest economy, however.

“We’ve already started to have exchange rates reform for quite long time...[but] it is gradual... it is good for a large economy otherwise it may be dangerous,” he told the BBC on the sidelines of this weekend’s International Monetary Fund meeting in Washington.

http://www.telegraph.co.uk/finance/8052729/George-Soros-warns-China-of-global-currency-war.html

China rejects quick yuan revaluation

October 9, 2010 - 4:19AM
.AFP

China's top central banker has rejected demands for a quick revaluation of the yuan, saying the emerging giant will reform gradually rather then engaging in "shock therapy".

Under fierce pressure from the United States, Europe and Japan, central bank governor Zhou Xiaochuan said on Friday the yuan will move gradually toward an "equilibrium" level.

With the recovery still painfully slow in the developed world, China and other emerging markets are being asked to allow a more level playing field for trade.

Advertisement: Story continues below Attempting to defuse simmering tensions, IMF chief Dominique Strauss-Kahn said China will not be expected to revalue its currency overnight.

But earlier on Friday, US Treasury Secretary Timothy Geithner gave a glimpse of Washington's impatience with the pace of reform so far.

"The United States believes that global rebalancing is not progressing as well as needed to avoid threats to the global economic recovery," he told the IMF's 186 other member states.

Geithner added the solidarity shown in the wake of the global financial crisis is at risk of disappearing as countries like China fail to switch the foundation of their economies from foreign to domestic demand.

© 2010 AFP

UK investors to study finance meeting

October 9, 2010

The London stock market may extend recent gains next week as investors digest the outcome of this weekend's international finance meeting in Washington amid fresh economic data and company results.

By Friday on the London Stock Exchange, the benchmark FTSE 100 index finished the week at 5657.61 points, up 1.16 per cent from a week earlier.

This weekend, major world powers are gathering in Washington to try and avert a damaging global "currency war" and address the weak level of the dollar.

Advertisement: Story continues below With recovery slowing, recent weeks have seen some nations intervene to stop their currencies from rising to levels that would make their exports prohibitively expensive.

That has sparked talk of a currency war and cast a shadow over global financial markets.

Finance ministers and central bankers from 187 countries are convening for the annual meeting of the International Monetary Fund amid concern that currency policies could wreck the fragile global economic recovery.

"From a currencies perspective, many will look to developments at the ... meeting to see if there is anything done to stop the dollar from weakening," said City Index analyst Joshua Raymond.

He added: "There could, however, be much volatility triggered by the third-quarter earnings season in the United States and a range of important economic data due out throughout the week.

"We are now in third-quarter season and so, naturally, we will see a shift in attention towards US companies that report.

"Next week we have Intel, JPMorgan, Google, General Electric all reporting and so, naturally, we will see European traders react to this," he added.

In Britain next week, there is data on inflation, unemployment and trade.

Key trading updates are due from mining giant Rio Tinto and drinks group Diageo.

© 2010 AFP