15 October 2010

Currency Wars and Competitiveness

Today's papers are full of talk of currency wars. The US dollar has fallen. China is accused of holding down the value of the Yuan. Brazil is using taxes to limit flows of hot money pushing up the value of the Real.


It is all about competitiveness and so we enter another stage on my quest to understand what that means.

If countries can increase their competitiveness by lowering the value of the exchange rate then we are talking about increasing exports and reducing imports. There is a tendency to report countries with a trade surplus, or more broadly a current account surplus, as competitive.

The question is should a lower exchange rate be an aim of economic policy? Should we look to become more competitive by reducing the exchange rate?

The obvious objection is that everyone can not become more competitive at the same time. If everyone tried to devalue 5% then their exchange rates would stay the same.

Globally the sum of all exports equals the sum of all imports. Every trade has an importer and an exporter. Increasing exports in one country increases imports elsewhere. This is why competitive devaluation is often called a beggar-my-neighbour policy.

The danger is that this turns into protectionism, reducing global trade and the benefits which that brings. Which happens to be one of the reasons why Krugman, in the article I quoted before, calls competitiveness a dangerous obsession.

What is happening right now is that there is not enough demand and so countries try to add to demand through increasing net exports, which amounts to taking demand away from other countries. What the world really needs is an increase in demand overall.

No comments:

Post a Comment