When exporting countries face stagnation, the almost universal solution that policymakers first think of is the devaluation of currency in order to promote export growth.
Back in 2012, before Japanese leaders devalued the yen, the US dollar bought 78 yen. But now, the greenback buys 124 yen.
This practice of devaluing the currency is a bonanza for exporters’ net income.
For example, when a Japanese company sold its product in the United States in 2012 for a price of $1, it will get 78 yen when the sale is converted back to the Japanese currency. Now that $1 is equivalent to 124 yen, the same product with the same price in USD will give the company a significant increase in revenues.
With this, it is rather unsurprising that devaluation is generally viewed as a magic bullet for stagnant profits and revenues.
However, it is important to keep in mind that one country’s devaluation becomes an immediate problem for other exporting nations. When a country such as Japan moved to devalue its currency, the goods became cheaper for people who purchase these products using euros, dollars and other currencies. Hence, other exporters who are selling their goods in the same markets will be negatively affected.
Obviously, the other exporting countries will make an effort to stay competitive and will also devalue its currency. This competitive devaluation of currencies is also called currency war. When this happens, the benefits of devaluation will somehow be limited and temporary.
Aside from this, devaluation itself can cause adverse consequences. One of this is the rapid increase in the cost of imports.
For example, when a country needs to import oil, food, medicine, and other essentials, the advantages of the devaluation of its currency may be substantially less than the negative impact caused by the increasing costs of imports.
Again, let’s take a look at the situation of Japan. The Asian country’s massive devaluation was intended to ramp up its exports and boost corporate profits, which in turn are supposed to spur increased employment and higher wages.
However, the positive consequences of Japan’s massive devaluation have been underwhelming.
Although some exporters have experienced significant boost in profits, which helped the stock market to jump to post-1990 highs, the outcome is not universally a good one.
Take into consideration the predicament of the corporations that must purchase soybeans from the United States in order to manufacture food products. The price of their raw materials will significantly increase because $1 of soybeans, which costs 78 yen before, is now equivalent to 124 yen.
Knowing that big exporters of products and services, such as Japan and China, are importers of food and oil, depreciation of currency is a ticking time bomb when it comes to the costs of energy and food.
The impending global recession and overinvestment in the production of commodities, which are driven by the central banks’ zero-interest rates, has led to a glut in the oil market and other commodities.
However, as marginal producers are compelled to cut production, supply and demand will balance at one point.
Eventually, exporting countries which have devalued their currency to reach soaring high levels of profits and revenues will see the costs of essential imports hit astounding levels, while the rewards of their devaluation fade away in the currency war they initiated.
Perhaps, it will be better if policymakers who are thinking of using devaluation as a remedy for stagnation will review and consider Frederic Bastiat’s idea about eventual consequences. The political economist asserts that it is quite often that when the immediate effects are advantageous, the later outcomes are devastating, and vice versa.
It is very important not to confine oneself only to the visible results, but to take into account both the consequences that are evident and those that must be foreseen.