A Case for Devaluation

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A Case for Devaluation

Here is a little something a friend shared with me. It has led to some interesting conversations and strategizing.

 

1) The first article was from the New York Fed itself (http://www.newyorkfed.org/aboutthefed/fedpoint/fed38.html).  "Under a fixed exchange rate system, only a decision by a country's government or monetary authority can alter the official value of the currency. Governments do, occasionally, take such measures, often in response to unusual market pressures. Devaluation, the deliberate downward adjustment in the official exchange rate, reduces the currency's value" Why might they do it and what would be the benefits? " 

 

Then, they go into the why's and effects: 

 

"Under What Circumstances Might a Country Devalue?

When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency's fixed exchange rate untenable. In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.

A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies. There are two implications of a devaluation. First, devaluation makes the country's exports relatively less expensive for foreigners. Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports. This may help to increase the country's exports and decrease imports, and may therefore help to reduce the current account deficit."  So, picture a market collapse....or another attack either here or abroad (Iran): perfect emergency to cover the devaluation.  The two effects of devaluation, we've already discussed. Now, here are some collateral 'benefits': 

"Effects of Devaluation

A significant danger is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can aggravate inflation. If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth.

Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be jeopardized. Thus, devaluation may dampen investor confidence in the country's economy and hurt the country's ability to secure foreign investment.

Another possible consequence is a round of successive devaluations. For instance, trading partners may become concerned that a devaluation might negatively affect their own export industries. Neighboring countries might devalue their own currencies to offset the effects of their trading partner's devaluation. Such "beggar thy neighbor" policies tend to exacerbate economic difficulties by creating instability in broader financial markets."  So, devaluation may cause inflation, psychological damage, and further devaluations, which could start a currency devaluation war (but the first country to do it big time may be the initial 'winner'."

 

2) Second article (http://www.telegraph.co.uk/finance/comment/jeremy-warner/6563688/Currency-devaluation-is-no-magic-bullet.html) is from the UK and good about not only the devalued Pound but also some good comments about Brazil's strong currency.  Summary: "Devaluation may make the economic correction feel less painful than the absolute reductions in wages and wealth that others are undergoing, but it amounts to much the same thing. Either way, the value of incomes and wealth are depressed.

Also, attempting to devalue your way back to growth will eventually provoke a protectionist response in others – and there's no telling where that would end."  It also says that devaluation did NOT help exports in Britain.

 

3) Here's a third, pretty compelling, reason why a massive devaluation may happen from another article on the Korean bank holidays (http://www.independent.co.uk/news/world/asia/north-koreans-dare-to-protest-as-devaluation-wipes-out-savings-1833156.html).  They bring out another result of the devaluation: "The (earlier) reforms have increased wealth disparities and incubated a growing class of wealthier farmers and merchants who are evading state controls and using bribery to keep government officials in line, say Pyongyang watchers. In January, the government failed in its attempt to rein in the reforms by limiting or closing private markets.

"Currency reform was probably the only option left to neutralize the wealthy merchant class," a North Korean defector and analyst, Cho Myong-chol, told Chosun Ilbo yesterday. "The latest measure has made everyone poor again and possibly raised the North Korean government's hopes of regaining control over its people."

News of Mr Kim's decree comes amid claims that the North's military has also reasserted control over mines and other areas of the economy in a bid to earn hard currency before the transition of power – likely to be one of the most traumatic periods in the country's troubled history. The army is reportedly selling minerals to China and hoarding the earnings.

Observers say the devaluation will destroy the savings of poorer and middle-class North Koreans while leaving wealthier traders, who have hoarded yuan, dollars and gold, mostly untouched. Analysts in South Korea were warning last night that the move could backfire and even spark revolt."  So, devaluation is a way to destroy the middle class (and anyone who 'doesn't get it' and moves into commodities that will weather the devaluation storm. 

 

4)  Here's an article that points out another reason for being the first to devalue big time: surge in employment (http://www.commodityonline.com/news/Next-danger-on-radar--Currency-devaluation-22092-3-1.html).  Warren Buffett calls it “a drug.” Ireland’s finance minister calls it “a weapon.” It’s one of the ultimate temptations for politicians. And, quite frankly, we’re about to see a lot more of it. Best of all though, the market is rewarding investors who have taken steps to protect themselves and profit from it. 

 

I’m talking about currency devaluation."  And, later in the article: "You see, the most politically appetizing benefit of currency devaluation is the initial jolt of employment. A sharp upturn in exports means more people will be working to produce those exports. And with official unemployment in the U.S. nearing 10% we’re witnessing the politically-welcomed devaluation of the dollar right now. Economist Simon Johnson has gone as far as calling the devaluation “Obama’s secret jobs plan.”

 

Worst of all, the political will to devalue the US dollar is only going to get stronger from here because unemployment will continue to be a problem thanks in large part to healthcare reform and the goal of green job creation."  Also, It doesn’t stop there. The other major legislation staring the economy down is the cap-and-trade scheme. Again, we’re not here to debate the scientific or political merits of global warming climate change. We’re here to look at the impact of the plan on business, the economy, and our investments.

 

If cap-and-trade is eventually passed, it will have the same effect as healthcare reform: increase the cost of employment.

 

Those increased employment costs will inevitably lead to - wait for it - even higher structural unemployment.

 

This is not a theory though. Spain has already been down the “cap-and-trade” road and they don’t like where it has taken them.

 

Back in March the King Juan Carlos University published a study on the country’s cap-and-trade system and job creation. The study found 2.2 jobs were lost for every one green job created.

 

Sure, you will have a few thousand folks who work in windmill and solar panel factories (and they’ll make great backdrops for presidential speeches). And the lack of tangibility of jobs lost make green jobs very politically favorable. But the transfer of wealth from some businesses to other less-efficient ones will just add to unemployment rolls here just like it has in Spain and everywhere else.

 

In the end, the net effect will be higher unemployment. And the politically favorable “quick fix” will be - you guessed it – more currency devaluation."

 

5) Then, there's a very good primer article on the Ludwig Von Mise's website and their take on Devaluation which was, for me, a very enlightening view and review on the subject: (http://mises.org/story/1345).

 

In summary, devaluation will be an attempt to increase exports, increase employment, destroy the middle class, tighten control on a dazed public, increase domestic production and probably also provide a means to pay off debt with much cheaper dollars. There are probably other reasons...Hey, we might even get a new war out of it!  

We have decided that it seems like a good time for a little economic shock and awe. We may see some kind of "emergency" in the short term to kick start the devaluation.

Thoughts?

V

 

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