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Currencies lose firepower as an effective trade weapon

Shawn Donnan
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When China's central bank last week triggered the two biggest single-day falls in the renminbi since the 1990s, plenty of people were keen to proclaim a resumption of the "currency wars" that have been a feature of the global economy since the 2008 financial crisis.

But if Beijing's move prompted a predictable political response from veteran currency warriors in Washington and other capitals, it ignored what many trade economists see as an increasingly well-documented fact — currencies are not the trade weapon they once were.

In a new study of 46 countries including China, economists at the World Bank found that currency devaluations are these days only half as effective a tool for boosting exports as they were in the mid 1990s.

Moreover, the World Bank economists found the more that countries became integrated into the global economy — as China has done in spectacular style since the 1990s — the less the effect was likely to be of any currency changes on their exports.

For countries such as China that weaken their currencies to seek competitive advantage in global trade, there is a "distinction between the perception of the impact of a depreciation and the actual impact a depreciation can have", says Michele Ruta, one of the study's authors.

The reality today, he says, is that years of data show the impact is likely to be much less than it used to be.

There are a number of reasons for that. But the biggest, say Mr Ruta and his colleagues, is the advent of global supply chains over the past two decades and the reality that many products today are agglomerations of parts made in many different countries

The result is a much more complex calculus for many economies such as China's and products that have become necessities of modern life.

More from the Financial Times:

Renminbi shift challenges global markets
China warns of fresh renminbi volatility
A currency skirmish that was not made in China

Weaker currencies do still lower the cost and therefore raise the international competitiveness of many goods exports while increasing the cost of imports.

For something as simple as a bottle of Australian shiraz squeezed from grapes grown on Margaret River vines, that reality still holds and matters. A weak Australian dollar will lower the cost of an exported bottle and make it more attractive to offshore consumers. It will also increase the price of imports into Australia of French or Chilean rivals, providing another boost to the local industry.

But for more complex products, like many of the electronic items assembled in China, the real impact is far more difficult to calculate.

Read MoreWhat China's yuan move means for emerging markets

In the case of a smartphone, for example, the screen may have been imported from Japan and the main chip from South Korea, while other parts are sourced in southeast Asia, Europe and even the US. So even as a weaker renminbi in theory lowers the price internationally of the finished product it also raises the cost of imported parts.

For that reason trade economists have increasingly begun to look at who gains the real "value-added" profits from products. Wherever you may buy an iPhone designed in California and assembled in China from parts from all over the world, most of the profits go to Apple not to Foxconn, the Taiwanese assembler or its workers in mainland China.

However, despite the shift in the global economy, in the case of China there is one reason why its exporters may gain more from a weaker currency than they once would have.

China's import intensity — how much of exports were made up of imported parts — has fallen dramatically in many categories over the past decade. China has been expanding its own homegrown supply chains, something trade economists have cited as one reason for slowing growth in global trade in recent years.

Did China's yuan devaluation spark a currency war?
Did China's yuan devaluation spark a currency war?

But beyond China the reality is that even big devaluations have done little to help exports.

In a note to clients this week, Marc Chandler, global head of currency strategy for Brown Brothers Harriman, pointed out that the Japanese yen had fallen more than 17 per cent against the dollar in the past year and yet Japan's exports in the three months to June posted the biggest quarterly decline in five years.

Similar patterns hold true in South Korea, Taiwan and even Germany, Mr Chandler says.

Taken together they point to a bigger malaise in the global economy, one that is unlikely to be overcome by any currency shifts.

"The key message that a lot of people miss is that the best thing for US exports, the best thing for Chinese exports, the best thing for European exports is not weakening currencies, it is stronger global demand," he says.