Strong/Weak Currency - Good or Bad?

[IchabodPlain]

I was wondering the benefits and consequences in having a relative weaker or stronger currency?

As far as I can tell the big advantages towards having one or the other concern whether a nation is export or import oriented. For instance:

Weak Currency - Good for nations which have a larger share of export than imports making up their GDP. An example of this is Japan, which relies heavily on it's exports, and having a weaker relative currency encourages more nations to buy their goods.

Strong Currency - Good for nations which rely more heavily on imports. Examples of this are the U.K. and the United States in which their stronger relative currency allows for less of their currency to purchase more from countries with a weaker currency.

A major negative to weaker currencies, I thought, were the possibilities that may result from having diminished purchasing power, but though I can say for sure how, I would think there is something governments with a weaker currency can do to offset this problem.

Negatives to a stronger currency..I can't so much think of them, except when a country goes from weak to strong - which would, again, relate to import/export issues.

Can anyone tell me how I am wrong, or what else that could be added to the positive or negative effects of a strong or weak currency?

 

[IMST]

If you have a trade imbalance, like the US, strong currencies can be a problem. Since it's cheaper to import stuff than make them locally, it hurts domestic manufacturing both intended for the domestic market and for export.

 

[Puppycow]

I think you have it about right, except that in the long term I think trade should trend toward balance by the mechanism of the currency of a country with a trade surplus gradually strengthening as a result of the trade surplus and the opposite mechanism for the country with a trade deficit. However, governments of export-oriented countries with a trade surplus seem to do everything they can to weaken their currency to thwart this process. It seems to me that this is effectively hoarding money at the expense of living standards, but it may have the benfit of providing for the coming Japanese mass retirement.

Perhaps Japan's trade deficit will finally turn negative?
Let's check the trend:
http://www.tradingeconomics.com/Economics/Balance-of-Trade.aspx?Symbol=JPY

Yes, the trend seems to be turning negative at last, although there are ups and downs.
In Japan they have the so-called "2007 problem," which was the year when the first cohort of post-war baby-boomers began to retire.

 

[atavisms]

Your points are probably valid but it is not black and white line ..
For example., a weaker dollar makes many US products more affordable to overseaes purchasers.

 

[Francesca R]

As far as I can tell the big advantages towards having one or the other concern whether a nation is export or import oriented. For instance:

Weak Currency - Good for nations which have a larger share of export than imports making up their GDP. An example of this is Japan, which relies heavily on it's exports, and having a weaker relative currency encourages more nations to buy their goods.

Strong Currency - Good for nations which rely more heavily on imports. Examples of this are the U.K. and the United States in which their stronger relative currency allows for less of their currency to purchase more from countries with a weaker currency.

Except that (to the extent that exchange rates are deterministic at all) countries with a persistent trade surplus (such as Japan, your first example) tend to have by definition a capital account deficit (net capital outflow) which makes them a net creditor of the rest of the world, which can often propel the currency stronger. And countries with a persistent trade deficit tend to be debtors to the rest of the world, which can often make their currencies weaker. So a loosely general result is the reverse of what you have. (The Japanese yen has generally risen against the US dollar)

If a net-exporting country had an ever weakening real exchange rate, then its trade surplus would tend to get bigger every year, and if a net-importer had an ever strengthening real exchange rate then its deficit would tend to get bigger too. Therein lies the route to destabilising "imbalances".

You could say--of course--that a country with a large trade deficit by (one) definition has a "too strong" exchange rate, and vice versa, because if the currency was weaker, the country would import less and export more, and the deficit would shrink or maybe eventually get back to balance.

In general there seem to be fairly wide margins within which trade imbalances, and significant positive or negative accumulated net foreign assets are "sustainable". Japan has owned a big chunk of the rest of the world for decades, and Australia has been owned to a chunky extent by the rest of the world for decades too. The best (IMO) long term determinant of exchange rates are differential inflation rates in tradeable goods and services (such as producer prices)

A major negative to weaker currencies, I thought, were the possibilities that may result from having diminished purchasing power, but though I can say for sure how, I would think there is something governments with a weaker currency can do to offset this problem.

Because weak currencies make import prices rise, they give rise to what is called "imported inflation", which means that this can lead to general economy-wide prices rising too fast, which can in turn require tighter monetary policy. The opposite happens with strong currencies. The effects vary depending on how open the economy is, which means how large imports are as a fraction of GDP. The Euro-zone is not very open (it trades mostly with itself), so big swings in the EUR exchange rate don't have much impact on Euro-zone consumer prices.

Negatives to a stronger currency..I can't so much think of them, except when a country goes from weak to strong - which would, again, relate to import/export issues.

Correct, which is widely believed to be the reason why China holds its currency at a weak level.

 

[IchabodPlain]

Thanks for the response

Except that (to the extent that exchange rates are deterministic at all) countries with a persistent trade surplus (such as Japan, your first example) tend to have by definition a capital account deficit (net capital outflow) which makes them a net creditor of the rest of the world, which can often propel the currency stronger. And countries with a persistent trade deficit tend to be debtors to the rest of the world, which can often make their currencies weaker. So a loosely general result is the reverse of what you have. (The Japanese yen has generally risen against the US dollar)

I understand the idea of a nation being a net creditor and debtor, being that, if as a nation, you are have consistent trade surpluses, the demand for your currency rises because other nations need to buy your products (and the reverse being true with a country who has consistent trade deficits). That is what will happen, however, that isn't what countries would prefer is it? For instance, Japan's government doesn't want the yen to rise over the long term to near what the dollar or Euro's value. Do they?

If a net-exporting country had an ever weakening real exchange rate, then its trade surplus would tend to get bigger every year, and if a net-importer had an ever strengthening real exchange rate then its deficit would tend to get bigger too. Therein lies the route to destabilising "imbalances".

And isn't this where a given country's government gets involve to stabilize such imbalances?

You could say--of course--that a country with a large trade deficit by (one) definition has a "too strong" exchange rate, and vice versa, because if the currency was weaker, the country would import less and export more, and the deficit would shrink or maybe eventually get back to balance.

I didn't so much think that having consistent trade imbalances are necessarily a bad thing (improved standard of living and all). I can see in extreme situations this could cause trouble, but it doesn't seem like an issue in realistic settings. This, I think, goes along with your next bit:

In general there seem to be fairly wide margins within which trade imbalances, and significant positive or negative accumulated net foreign assets are "sustainable". Japan has owned a big chunk of the rest of the world for decades, and Australia has been owned to a chunky extent by the rest of the world for decades too. The best (IMO) long term determinant of exchange rates are differential inflation rates in tradeable goods and services (such as producer prices)

Could you explain more, or refer me to an article explaining more about differential inflation? From my rough understanding, it is the difference between the inflation of a tradeable good or service, and the inflation of a given currency. Is that in the right zipcode?

Because weak currencies make import prices rise, they give rise to what is called "imported inflation", which means that this can lead to general economy-wide prices rising too fast, which can in turn require tighter monetary policy. The opposite happens with strong currencies. The effects vary depending on how open the economy is, which means how large imports are as a fraction of GDP. The Euro-zone is not very open (it trades mostly with itself), so big swings in the EUR exchange rate don't have much impact on Euro-zone consumer prices.

At what percentage of imports:gdp do issues of imported inflation cause serious problems? What are some real world examples of this?

 

[IchabodPlain]

Your points are probably valid but it is not black and white line ..
For example., a weaker dollar makes many US products more affordable to overseaes purchasers.

I have never said it was a black and white issue. Your point, however, that other nations may take advantage of a rise in inflation elsewhere and that it serves as an automatic stabilizer of short-term problems boosting exports is one well taken.

 

[IchabodPlain]

I think you have it about right, except that in the long term I think trade should trend toward balance by the mechanism of the currency of a country with a trade surplus gradually strengthening as a result of the trade surplus and the opposite mechanism for the country with a trade deficit. However, governments of export-oriented countries with a trade surplus seem to do everything they can to weaken their currency to thwart this process. It seems to me that this is effectively hoarding money at the expense of living standards, but it may have the benfit of providing for the coming Japanese mass retirement.

Right. I think you hit the nail when you say that nations do everything in their power to thwart the process. Taking your example of the negatives to thwarting this process (cost to standard of living), can you please go into more detail concerning this? How is the money "hoarded"? Under what program are these "hoarded" funds deposited to provide for the near-term retirement boom?

Perhaps Japan's trade deficit will finally turn negative?
Let's check the trend:
http://www.tradingeconomics.com/Economics/Balance-of-Trade.aspx?Symbol=JPY

I would think the global economic problems may have played a part in the downward trend of surplus as of late (late '08-early '09).

In Japan they have the so-called "2007 problem," which was the year when the first cohort of post-war baby-boomers began to retire.

How did that turn out?

 

[Francesca R]

however, that isn't what countries would prefer is it? For instance, Japan's government doesn't want the yen to rise over the long term to near what the dollar or Euro's value. Do they?

Politicians usually want their currency to be somewhat weak, yes, but not too weak. But they allow their hands to be tied by discharging monetary policy to independent central banks in most cases. That still leaves market intervention (officially selling the currency) in the hands of finance ministries, but this does not happen so much. The Japanese government did intervene to sell yen regularly up to 2004 but have not done so since. Current wisdom seems to be that intervention is pretty ineffective.

I didn't so much think that having consistent trade imbalances are necessarily a bad thing (improved standard of living and all). I can see in extreme situations this could cause trouble, but it doesn't seem like an issue in realistic settings.

There's an elusive nondefinite "tipping point" which countries have crossed into balance of payments crises. Most often "emerging" (poor) countries, but the UK experienced this in the 1960s

Could you explain more, or refer me to an article explaining more about differential inflation? From my rough understanding, it is the difference between the inflation of a tradeable good or service, and the inflation of a given currency. Is that in the right zipcode?

Nothing to hand at the moment but you could look up the theory of "purchasing power parity" and Kenneth Rogoff (Harvard)

 

[Puppycow]

Right. I think you hit the nail when you say that nations do everything in their power to thwart the process. Taking your example of the negatives to thwarting this process (cost to standard of living), can you please go into more detail concerning this? How is the money "hoarded"? Under what program are these "hoarded" funds deposited to provide for the near-term retirement boom?

In japan it's the private sector, mostly individuals I think, who hoard the money. The government itself is actually quite deeply in debt as a result of continuous programs since the bubble burst to stimulate the economy and devalue the currency. Much of the money is simply held in postal savings accounts or bank accounts which in turn mostly invest in government bonds. The rest is in various investments such as japanese stocks, overseas stocks and bonds, REITs and other things that investors invest in.

I would think the global economic problems may have played a part in the downward trend of surplus as of late (late '08-early '09).

No doubt it did, but I also think there is a secular shift happening as Japan retires.

How did that turn out?

Well it's a problem that only started in 2007. Every year from 2007 on more people will retire than will enter the workforce. So far, its hard to say how much effect this is having because of the global economic crisis. The GDP has gone down, but mostly due to the effects of the financial crisis.

Here's the long-term trend:
Real GDP growth in Japan 1956-2008

 

[Francesca R]

Well it's a problem that only started in 2007. Every year from 2007 on more people will retire than will enter the workforce.

Japan's total population has been falling since 2005. I am pretty sure the working-age population has been shrinking since the 1990s.

ETA--I made the chart below from the data in the first excel attachement on this page which is the government's labour force survey (each column is the year's average; 2009 is up to July)

 

[Puppycow]

Thanks Francesca. Looks like it peaked in the late 90s.

The yen has recently been getting stronger again based on comments by the new finance minister.

Yen Rises to 8-Month High on Speculation Japan Won’t Intervene

Stock markets reacted negatively to the yen's strength

However, Japanese individuals purchasing power increases.
The deflation here is noticeable if you live here long enough. Especially in manufatured goods.
Food seems to be an exception.

The yen and the won are going in opposite directions, which is good for Korean companies and bad for Japanese companies.

The currency’s gains have made it harder for Japanese exporters such as Panasonic Corp. and Toyota Motor Corp. to compete with rivals in South Korea. The Korean won has depreciated 23 percent versus the dollar in the past two years just as the yen surged 26 percent.

‘See the Damage’

“You can see the damage from the yen if you look at Japanese exports compared to Korean exports,” said Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo. “Korea’s done much better over the last year and if you look at the won-yen exchange rate that tells you a lot of the reason.”

Record sales helped Samsung Electronics Co.’s profit climb 5.2 percent last quarter, while Panasonic suffered a net loss as revenue dropped 26 percent. Hyundai Motor Co. has taken market share away from Toyota: The South Korean carmaker’s U.S. sales dropped less than 1 percent in the first eight months of the year, while Toyota’s plunged 29 percent.

“We’re affected by exchange rates, there’s no doubt about it,” said Paul Nolasco, a Tokyo-based spokesman at Toyota, which based its earnings estimates on the assumption that the yen will trade at an average of 92 to the dollar in the next six months. The automaker forecasts a 450 billion yen ($5 billion) net loss for the year ending March 2010.

Competition From China

Japanese companies also face competition from China, where authorities have stalled currency appreciation against the dollar since July last year to protect exporters. Chinese companies at a trade show in Shanghai this week urged the government to delay gains in the yuan.

 

[Corsair 115]

Canadians are well aware of exchange rates. With some 80% of our exports going to the United States, the Canadian dollar's strength agains the U.S. is of considerable importance.

In January of 2002, the Canadian dollar was at an all-time low against the American dollar, being worth just $0.62 US. Five-and-a-half years later, in November of 2007, it had soared to an all-time high of $1.10 US. Naturally, this put enormous pressure on exporters who had been for years taking advantage the low Canadian dollar to their benefit.