The Guest Blog

Devaluing Your Currency: Not a Panacea After All

Moorad Choudhry | Treasurer, Corporate Banking Division, Royal Bank of Scotland

Whatever the reasons behind Mitt Romney's failure to convince the U.S. electorate that he was the man for the job, and there are myriad explanatory factors, it seems his team's position on economics was one of them.

Or, at least, his arguments didn't convince the voting taxpayer — whether they were correct or not remains open to debate. With the country still struggling to meaningfully escape recession and new job creation levels barely denting the rate, a more convincing candidate should have been able to win the economic policy argument (if he still lost the foreign policy one).

That Mr Romney didn't win the economic debate says something about the change in culture and attitude since the 2007-08 crash. Monetary policy easing has been the consensus on both sides of the Atlantic for some time. One of the loudest complaints from the Republican side was directed towards the Federal Reserve, and its "debasing" of the currency. In a nutshell, the charge here is that continuous zero interest rates and "quantitative easing" have devalued the U.S. dollar to a dangerous extent, and also risks stoking up . At the very least, this action raises the cost of living for domestic consumers as a result of dearer imports, and also reduces savings income in real terms.

A "cheaper" currency does have one merit — it makes a country's goods and services more attractive to an external third party. So export volumes should rise and this in turn helps economic output growth. This has driven the longstanding currency strategy of the so-called "export-led" economies in Asia.

Cheaper currency = more exports is the traditional case. But one should always be wary of single-factor arguments like this one. There are many reasons behind the decision to import, and a stronger currency at home is a major but by no means the most influential reason, let alone the only one. We need only look at the U.K. economy for evidence of this.

Since the summer of 2008 sterling has devalued nearly 20 percent compared to its highs of that year. In the period from March 2009 to now, during which the Bank of England's base interest rate has stayed at an historical low of 0.5 percent, sterling has moved essentially in a narrow range of 1.50-1.65 (this excludes one-off outliers down to 1.45 and up to 1.70 in this time) against the dollar, which is a significant devaluation in the past 4 years compared to the previous 4 years.

So have U.K. exports soared in this time? Well, as one would say about a business trip to an unsavory destination, it's been nothing to write home about. The fact is that U.K. export performance has lagged and the trade-related balance of payments has worsened since sterling devalued. In other words, we have imported more since 2009 than we have exported.

So much for the export panacea of a weaker currency! There is more to it than that of course, but the fact remains that weaker sterling hasn't helped exports, yet we are still left with inflation worries as well as a higher cost of living due to more expensive imports. This is what the U.K. is facing right now. Proactively looking to maintain sterling as "weak", which seems to be the message coming from the BoE (we could be wrong of course, but if Alan Greenspan is to be believed central bank communications are meant to be opaque are they not?), could be a risky strategy.

So perhaps on the U.S. dollar front the Republicans had a point? In 2008 and 2009 there was no doubt at all about what direction policy action had to take. The Western economy was looking into an abyss of depression and deflation, and it demanded urgent action on interest rates and money printing — and got it. But in 2013 the economic outlook is nothing like as dire and the euro zone crisis has calmed (although its structural problems remain with us). Preserving the value of one's currency still has merit and thinking that a devalued currency is worthwhile because it is good for exports is an unbalanced argument.

Two countries spring to mind here: Greece, which some analysts suggest would benefit from a devaluation arising from leaving the euro (it would, but that wouldn't get its economy growing again, because its problems go far, far beyond mere currency-related ones) and China, where the central bank is gradually realizing that the Chinese economy is maturing and is less reliant on a currency kept at a below-market value. At some point we will have a freely-floating and liquid renminbi, and the Chinese economy will still be running a trade surplus for some time to come irrespective of this.

A weaker currency doesn't hinder exporters, but in the long run it doesn't help the economy or the taxpayer either. What was right in 2009 ain't necessarily so in 2013…