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How does debasing your currency help exports?

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cr113 posted on Wed, Feb 2 2011 1:47 PM

I can't figure out how debasing your currency helps exports. Here's an example:

Suppose that the US and Canadian dollars are one to one. If a Canadian wanted to buy a six pack from the US he could exchange 5 Canadian dollars for 5 US dollars and buy the six pack for 5 US dollars. Now suppose the US doubles it's money supply. Now if the Canadian exchanges his 5 Canadian dollars he gets 10 US dollars, since the value of the US dollar has ben cut in half. But when he goes to buy the beer he finds that the price HAS ALSO DOUBLED to 10 US dollars. So the price for US beer has remained constant. How does this make exports cheaper?

Hopefully this doesn't double post. I tried once and it didn't appear to work.

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My answer would be that inflation causes the currency to devalue more quickly than it causes prices to increase. Newly crated money isn't directly released into the hands of the beer-buying public. A lot of it goes to financial instruments where it's just a number in a computer and into the hands of people that won't spend it on beer. So while there is a lot more money around, commodity prices don't increase at the same rate.

"They all look upon progressing material improvement as upon a self-acting process." - Ludwig von Mises
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Your model is assuming that the nominal price inflation/deflation that occurs as a result of artificial manipulation of the money supply would be instantaneous and that no income/substitution effects would occur.  Assuming a lag time between monetary expansion and rising prices, if you one day woke up to find your purchasing power seemingly doubled would you continue to buy to same quality or quantity of goods and services that you had purchased at the original exchange rate? 

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Suggested by krazy kaju

Well, if a producer makes six packs in both Canada and United States - and the costs to producing them are exactly equal.

Then let's say the U.S. dollar is devalued by 50% vs the Canadian dollar - then there is an argument that the costs to produce the six pack in the United States will now be cheaper than in Canada - so Canada will buy more six packs from the United States.

The main reason the costs will be cheaper is labor - which is the largest expense for most companies. If the dollar is devalued 50% - you can bet your arse that labor costs will not double. Only raw ingredient costs will double. So the United States labor will be paid substantially less (in real terms) than Canadian labor. This will make production costs less in the United States than in Canada (in real terms.)

So debasing the currency helps with exports because (in real terms) it reduced the standard of living of your citizens. In effect, it makes your country poorer and therefore labor is cheaper.

Great plan, huh?

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cr113 replied on Wed, Feb 2 2011 4:09 PM

I can see exports getting cheaper if there is a lag between the currency exchange rate changing and the price changing. But I also would expect this to be temporary. Eventually if you double the money supply, I think you will double everything, the exchange rate and the final price. Also screwing around with the currency is going to make it more difficult for businesses to operate and that will drive up costs. Also I think heard Peter Schiff mention that most countries that run a trade surplus are countries with strong currencies.

Anyway I'm preaching to the choir here about the negative effects of printing money! We all agree it's a bad thing.

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cr113:
I can see exports getting cheaper if there is a lag between the currency exchange rate changing and the price changing. But I also would expect this to be temporary. Eventually if you double the money supply, I think you will double everything, the exchange rate and the final price.

The answer is that exchange rates not only depend on the money supply of a country, they are determined by the demand for that currency by other countries. To buy a countries exports other countries need that countries currency, and if there is more demand for a currency it's price will go up.

"They all look upon progressing material improvement as upon a self-acting process." - Ludwig von Mises
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cr113 replied on Wed, Feb 2 2011 5:20 PM

EmperorNero:

Suppose there are only 2 countries in the world, Canada and the US. Suppose they both allow their currencies to float freely and the result is a one to one exchange rate. If the US then doubles its money supply I'm willing to bet that the exchange rate between the 2 countries will eventually float to 1 Canadian dollar to 2 US dollars. Exactly for the reason Milton Friedman states.

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That's true. But I think you asked why an artificial debasement of the currency would have effects on exports. The suggestion being that price increases would negate any debasement of the currency. The answer to your question is, I think, that exchange rates are not just determined by the money supply, but also by supply and demand of currencies. If Japan and Canada both want beer from the US, they will bid for Dollars with their respective currencies. And that will determine the price of Dollars. So for example a weak yen means that the Japanese are getting fewer US Dollars for their yen so US Dollars will be cheaper in terms of Canadian Dollars. If a country artificially debases it's currency it makes it's exports more affordable. Of course that doesn't make it richer.

"They all look upon progressing material improvement as upon a self-acting process." - Ludwig von Mises
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cr113 replied on Thu, Feb 3 2011 9:14 AM

EmperorNero,

The more I think about this the less sense is makes that artificially debasing your currency would help exports. It seems like it will actually do the opposite if you follow Milton Friedman's logic. Go back to my Canada-US example where Canada and the US are the only 2 countries in existence. Starting off the exchange rate is 1 to 1. Beer cost $5 in both countries. US artificially doubles its money supply. I would think that the first thing that would happen is that the price of beer in the US would start climbing, lets say to $6. Now it would be cheaper for citizens of both countries to buy beer in CANADA since the exchange rate is 1 to 1! So THEN there will be a rise in demand for Canadian dollars which will raise the exchange rate. So how would that EVER help US exports? The US inflation is actually going to make US exports more expensive in the short term.

Are there any real world examples of a country debasing its currency and increasing exports? Zimbabwe? Argentina?

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EmperorNero,

Just to add to your demand-side analysis, that is why lower individual, capital, and corporate taxes can also increase the value of a currency. Lower taxes on income in one country will act an an incentive for individuals to invest more in that country. Take the US and Canada as an example. If the US lowers these three taxes, then more Americans will have a greater incentive to invest in American assets, as opposed to Canadian assets. Furthermore, more Canadians will have a greater incentive to exchange their Canadian Dollars for US Dollars and invest in American assets. The result is that the USD rises against the CAD.

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I'm even more confused. My thinking is that exchange rates are determined by what each currency can buy, or goods prices. If the Canadian dollar goes from 1:1 to 1:2 against the US dollar, doesn't that mean relative prices have doubled? Why else would it take twice as many Canadian dollars to buy one US dollar???

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I read most of the answers and they all seem to be wrong or misguided. The infamous "inflation helps exports" doctrine/belief exists because of what some countries, notably China and Japan, have done. They are so-called export economies. What does China do? China(the Chinese central bank) prints large amounts of the Renminbi, then goes on the foreign exchange markets and dumps Renminbi in exchange for U.S. dollars. The printed Renminbi must then be used to buy stuff from the exporters since it is received by foreigners(U.S. citizens). It is a simple redistribution from savers of the chinese currency to the U.S. citizens who receive large amounts of Renminbi in exchange for their U.S. dollars.

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Jesse Cohen:
I'm even more confused. My thinking is that exchange rates are determined by what each currency can buy, or goods prices. If the Canadian dollar goes from 1:1 to 1:2 against the US dollar, doesn't that mean relative prices have doubled? Why else would it take twice as many Canadian dollars to buy one US dollar???

If the Canadian dollar goes from 1:1 to 1:2 against the US dollar, it means you can buy 2 US dollars with 1 Canadian dollar.  Meaning it takes half as many Canadian dollars to buy one US dollar...not twice as many.

 

Lawrence:
I read most of the answers and they all seem to be wrong or misguided. The infamous "inflation helps exports" doctrine/belief exists because of what some countries, notably China and Japan, have done. They are so-called export economies. What does China do? China(the Chinese central bank) prints large amounts of the Renminbi, then goes on the foreign exchange markets and dumps Renminbi in exchange for U.S. dollars. The printed Renminbi must then be used to buy stuff from the exporters since it is received by foreigners(U.S. citizens). It is a simple redistribution from savers of the chinese currency to the U.S. citizens who receive large amounts of Renminbi in exchange for their U.S. dollars.

That doesn't answer the question.  You haven't offered anything on this topic.  Please explain what is "wrong" or "misguided" about the answers given.  (Particularly the article linked in the first response here.)

 

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My main point was that it only helps exports because it is a redistribution of wealth from the savers of the currency being debased to the receivers of the printed money. Therefore, it only helps exports as long as the money lands in the foreign exchange markets or in the hands of foreigners who will purchase from the exporters.
If the government prints money and then gives it to a citizen of the nation and then he spends it, it will make domestic prices rise first and so there will be no benefit to exports.(This was previously mentioned.)

Some answers mentioned "income/substitution effects" and the "costs to producing", which wasn't wrong but really wasn't a precise answer. The relevant answer is that the fundamental cause of an increase in exports through inflation is that wealth is robbed from savers and given to people who will buy exports.

The reason everyone(Keynesians and socialists) believes that debasing a currency helps exports is because of the exports minus imports aspect of the GDP and because of how the export-led economies have operated. 

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