The Harsh Reality of Floating Currencies

It's presently settled logic among most financial commentators that countries gain when their monetary authorities devalue their currencies. The flawed assumption is that cheaper currencies make the devalued country's exports more competitive on world markets.

That England and the U.S. rose to superpower economic status through adoption of strong, stable currencies doesn't seem to concern the devaluationists, nor does Japan's rise in the ‘70s and ‘80s despite a yen that crushed the dollar. That no country in history has devalued its way to long-term prosperity also doesn't seem to deter a commentariat that apparently believes if we just devalued the foot, we'd all be taller. 

Well, if we ignore how devaluation drives up the costs of the inputs necessary to create a finished product -- meaning inflation always steals the supposed benefits of devaluation -- not commented on enough are the myriad other negative tradeoffs that result from currency debasement. Thankfully last Wednesday's Wall Street Journal offered some insight into the painful costs foisted on individuals in countries that devalue.

According to the Journal, Dezso Koc's family restaurant was booming in Budapest, Hungary back in 2007. Confident in future growth, Koc borrowed the equivalent of $150,000 in Swiss francs in order to take advantage of lower rates of interest charged on credible currencies like the franc. He then converted the francs into forints, the Hungarian currency.

All was well until the financial crisis of 2008 hit, and Hungarian monetary authorities allowed the forint to plummet. Still servicing debts denominated in francs, Koc saw his franc debt nearly double thanks to the forint's decline. Unable to pay the loan, lenders are set to foreclose on the family's home.

Stories like this abound in a world of floating currencies where many individuals borrow more credible currencies at lower interest rates, only to convert them to the local currency. As the Journal noted, in impoverished Romania 60% of borrowing occurs with foreign currencies, 36% in Poland, and 70% in Hungary. Much the same occurred in Asian countries in the late ‘90s when debtors were wiped out due to local devaluations that significantly increased foreign debts.

The allegedly wise minds who comment on financial matters rarely consider the second, third and fourth results of their knee-jerk advice to governments in favor of currency debasement. All they see is the largely illusory firsthand result of devaluation that supposedly makes exports from the devaluing country more attractive.

Not considered are the debtors in these countries who see their debt-service costs skyrocket due to the mercantilist leanings of their monetary authorities. Also not considered is the basic truth that trade is a two-way street. In order to export, individuals must import, but with their money devalued, their ability to import is severely compromised.

Savers, as Adam Smith taught us, are society's ultimate benefactors for their savings funding the creation of innovative new products, along with the wages of the individuals eager to bring new products to the marketplace. But in a largely Keynesian-dominated commentariat saving is decried, while devaluation is elevated.

Of course the savers in devaluationist scenarios are wiped out, which means there's no incentive for the prudent to delay consumption so that entrepreneurs can innovate, and willing workers can attain jobs. It's so obvious as to not merit mention, but there are no jobs and there is no economic advancement without saving and investment, but so captivated are governments and commentators by devaluation, it's a fool's errand for the parsimonious to do anything but consume with abandon.

Looking across countries, it is a truism that the ones which attract the most investment are always and everywhere noted for their high standards of living, but devaluation discourages foreign investment too, and with it the capital that makes individuals within countries better off. Usually it's the ailing special interests with strong government connections that call for currency debasement to make that which isn't working appear more robust, but not considered in this equation are the successful businesses reliant on the aforementioned foreign and domestic investment that must suffer the devaluation pain so that their weak counterparts can be propped up.

The sad reality to all this is how very unnecessary currency devaluations are if the goal is to make certain products more competitive. Indeed, if the desire is to export, the easy answer for businesses that would spare others devaluationist hell would be for them to simply lower their prices.

This is something governments and their enablers in the commentariat might consider one of these days. Devaluation quite simply does not work.