Over the years we have grown accustomed to listening about the value of our currency (the Malta lira previously and the euro now), without giving much thought to what the impact of an increase or decrease in value really means. Moreover, with the introduction of the euro as our currency, there was the correct positive perception that Malta would be better off by forming part of a monetary union and by having an internationally recognised currency as its currency.
Again, playing on perceptions, we all feel better when we learn that the value of our currency has increased and feel worse when the opposite happens.
However, the value of currencies goes well beyond perceptions. When a currency increases in value, it would mean that goods and services produced in the country where that currency is used have become more expensive when compared to other countries.
This means imports become cheaper. Similarly, when the currency decreases in value, the cost of producing a good or service goes down when compared to other countries, resulting in cheaper exports. In fact, students of economics learn that when a country wishes to boost its economy through increased exports, it would tend to devalue its currency.
Another point to consider is that when a country imports more than it exports, thereby creating a deficit in its balance of payments, one way of addressing such a deficit is through a currency devaluation to increase the competitiveness of businesses operating in that country. All this thinking was developed well before the euro was even conceived. It was developed at a time when currencies had not become the traded commodities they are today and when the value of currencies was backed by something far more tangible than simply what the market dictates. It was a time when capital could not move freely from one country to another and it was not possible to make money simply through speculation in currencies.
However, the basic concept that if a currency increases in value, a country’s exports become more costly – even though the cost of production would not have increased – is still valid. The consequence of this today is that those countries that can still exercise a form of control over the value of their currency, seek to keep that value down to sustain their exports. On the other hand, there are countries which just cannot exercise much control over the value of their currency, unless they intervene directly in the international currency markets.
The eurozone has a further complication. Not only is it subject to the effects of speculation, with little that can be done to mitigate such effects, but it encompasses a number of economies that differ greatly in their performance. Thus, although a country such as Greece may require a devaluation of the euro to boost exports, such a devaluation may be harmful to another country within the eurozone. The responsibility for monitoring the impact of the value of the euro lies with the European Central Bank, and it is up to the ECB to intervene where necessary.
One of the challenges the euro is facing today is that its value is increasing. Earlier this month, it hit a 15-month high against the dollar. This can have a serious negative impact on the economic recovery within the eurozone and force down the inflation rate too fast.
The president of the European Central Bank, Mario Draghi, has stated that the ECB needs to assess more thoroughly the impact of a stronger euro on inflation and growth. He was evidently responding to the debate that occurred among the G20 on competitive devaluations between the world’s economic powers, that is countries competing to weaken their currencies to sustain exports.
It needs to be kept in mind that when the euro was launched in 1999, its value was 1:1.17 against the dollar. Today one euro is worth around $1.35. What makes this even more challenging is the fact that Japan’s recent expansionary economic policies have driven down the value of the yen, while countries who have pegged the value of their own currency to the dollar enjoy a competitive advantage over the eurozone countries, even though their strong economic performance would suggest that the value of their currency should increase.
It is this whole scenario that has brought to the limelight the issue of a currency war. It is an undeclared war, but it would be foolish not to believe that it exists. India, China and Brazil have also enjoyed strong economic growth because they intentionally kept low the value of their currency. There is a risk that economic recovery in Europe would be slowed down because of the strength of the euro. It may be politically incorrect to talk of a currency war, but it is important that we all watch out for it.