Most of us only bother about exchange rates when we travel to countries whose currency is not the euro or when we buy things online that are priced in US dollar or in sterling. In most cases such mundane issues are all that matter.
Tourists from the UK, for instance, should feel a sense of relief that the sterling is strong and they can travel to the eurozone countries at a lower cost than was the case a year or so ago. For Maltese tourists going to the UK for a holiday it means that they need to make more detailed calculations to decide whether they should rather consider Ireland or France for their holidays.
But economic analysts have to grapple with far tougher issues to understand what is happening in the currency markets. Two major devaluations in the last months are likely to affect us quite profoundly, especially when we examine them in a more comprehensive economic context.
In the last year or so the dollar has been appreciating against the euro very steadily. In theory this should help exports to the US from eurozone countries to be more competitive. Naturally, the US government and exporters are worried about this as they do not want the rather impressive US economic growth to be stalled by the strength of the dollar. The expected interest rate increases in the US are likely to continue to strengthen the dollar even further.
Another bonus for eurozone countries is that oil can be bought more cheaply as it is priced in dollars. Perhaps more important, the price of oil is once again falling mainly because of oversupply in the market. This may be giving a boost to most economies in the eurozone but we need to be careful not to rely on growth that is based on extraordinary factors that make our costs appear lower. The current fall in oil prices will not last forever.
Early in August the yuan was devalued by almost four per cent. Market analysts are at a loss as to what is really behind the Chinese authorities’ decision to devalue their currency
A more recent development is the fall of the Chinese yuan. Early in August the yuan was devalued by almost four per cent. Market analysts are at a loss as to what is really behind the Chinese authorities’ decision to devalue their currency. Since 2005, the yuan’s real effective exchange rate has risen by more than 50 per cent, with almost a third of that rise coming in the past year.
Put simply, China’s economy needed help. The economy is expected to grow less than seven per cent this year, its slowest since 1990. The stock market has been in freefall since June. Many argue that a four per cent devaluation will not affect these negative pressures on the Chinese economy. Sung Won Sohn, an economist at California State University cautions: “There is too much excess capacity, especially in basic industries like steel, aluminium. There is also a real estate bubble that continues to inflate. Chinese banks are loaded with a lot of problem accounts.”
The US and EU authorities look at these developments with concern. Was the yuan devaluation a competitive devaluation to make Chinese products cheaper for Western economies? Are the Chinese trying to export deflation to Western countries? Or is this a move by the Chinese authorities to let their currency float more freely so that it can eventually become a reserve currency like the US dollar and the euro?
American politicians have long waged a war of words against China, arguing that “China keeps currency artificially low to give its exporters an edge. News that China has yet again lowered the value of its currency is another harsh reminder that we cannot afford to sit by as China refused to play by the rules”, Ohio Senator Rob Portman declared.
The pegging of the yuan to the dollar means that in the last year the Chinese currency has appreciated considerably. This was good news for eurozone exporters – especially those that manufacture luxury goods like BMW and Mercedes. Now the euro in bound to appreciate against the yuan as the Chinese authorities are not ready to continue to follow the pegging of the yuan to the dollar so scrupulously.
The big dilemma that faces the Chinese authorities is the extent to which they are prepared to let the yuan fall. Devaluations rarely have long-term benefits. A falling yuan will undoubtedly see a flight of capital from China. What China needs is more foreign capital inflows to renew investment in its aging industries.
johncassarwhite@yahoo.com