It is commonly held that countries can gain an economic advantage by devaluing their currencies against those of their trading partners. This is often referred to as the “beggar thy neighbor” tactic. I don’t see how it can possibly benefit the country doing it. I have tried to discuss this with several folks who are much better versed in these matters than I  — some with PhD’s in economics — and they seem very sure that the devaluing country does gain an advantage, but I still don’t see it.

To explain where my understanding seems to go off the rails, I’ll take an oversimplified example. A year or so ago, Switzerland found its currency appreciating against the Euro (and just about everything else), so it arbitrarily instituted a “peg” at 1.20 SF to the Euro. In other words, the Swiss franc would not be allowed to rise above that level. If it started to, the Swiss central bank would print more Swiss francs and use them to buy Euros, in whatever quantities might be necessary to keep the Swiss franc from rising in value. When this policy was announced, the value of the Swiss franc immediately dropped like a stone. How much depends on which currency you’re comparing with and over what time frame, but for purposes of today’s exercise let’s call it 15%.

Now, it should be obvious that this ‘gift’ is not actually a benefit to the Swiss citizenry, as eloquently argued here. For the ordinary Swiss citizen, anything imported that is priced in Euros must immediately cost 15% more. Switzerland is a small country. There are 34 cities in the world with populations larger than Switzerland. So it’s a safe bet that a lot of Switzerland’s fuel, food, cars, etc. come from outside Switzerland and are priced in either dollars or Euros. So the consumer immediately gets to start paying 15% more for all those things.

Usually the response is, “ah, but the country’s exports will leap ahead because to someone paying in Euros Swiss products will be 15% cheaper.” This is the part that seems nuts to me. In effect, you’re just cutting your prices, which doesn’t seem like a very clever way to make more money, unless you were overcharging in the first place.

Consider a hypothetical exporting company, call it Swiss Chocolate Co. Assume it makes and sells chocolate bars for export. To make the math simple, assume that before the devaluation, 1 SF is equal to 1.15 Euros, and after the devaluation, 1 SF = 1 Euro. Before the devaluation, each chocolate bar sells for 4 SF, or 4.60 Euros and costs 3 SF, or 3.45 Euros, to produce. The costs are 1 SF (1.15 Euros) for imported cocoa, 1 SF (1.15 Euros) for locally produced milk and sugar, and 1 SF (1.15 Euros) for local labor. So the profit is 1 SF (1.15 Euros) per chocolate bar. Assume the company sells 1 million chocolate bars per year — the profit is 1M SF, or 1.15M Euros.

After the devaluation, the costs are 1.15 Euros (1.15 SF) for the imported cocoa, 1 SF = 1 Euro for the milk and sugar, and 1SF = 1 Euro for labor, and the price received is 4 SF (4 Euros) so the profit per chocolate bar went down from 1 SF (1.15 Euros) to 0.85 SF (0.85 Euros) So the company’s costs went up, and the profit per unit went down. Yes, I understand that if the lower prices caused the company’s sales to double, it would make a bigger total profit. If it were selling 1M chocolate bars before the devaluation for a total profit of 1M SF (1.15M Euros), now it would be making a total profit of 1.7M SF (1.7M Euros) selling 2M chocolate bars. To do so, the company has to double its production, so presumably it hires more local workers, and buys more local milk and sugar, so everyone benefits, right?

Here’s the part I don’t get: the only cause of the increase in sales is, presumably, the effective lowering of the price to buyers who are paying in Euros. But the exact same effect could have been achieved simply by lowering the price of chocolate bars by 15%. Now, obviously, the whole price would have to come down by 15%, so in the absence of the devaluation, that would mean lowering the price from 4 SF to 3.40 SF to get the same 15% reduction. So the local workers would have to take a 15% pay cut, and the suppliers of the milk and sugar would have to take a 15% price cut. But they’re doing that as a result of the devaluation anyway.

In other words, if there were a way to adjust all local prices and wages downward by 15%, you would get exactly the same effect as the devaluation, except now you would avoid having to pay an extra 15% for the cocoa, and all the local workers and suppliers would be better off because every thing they buy that is imported would also not go up in price by 15%, as it would in the devaluation. So the company and everyone else in the country would be better off — they get the benefit of increased sales by simply lowering prices, and they get the benefit of being able to continue to buy foreign goods cheaply because of the strong currency. And the stronger the currency gets, the better off everyone is!

So why don’t countries do this instead of devaluing? Presumably because politically, it would be a hard sell to certain powerful elements, like organized labor. It would have to be done in a coordinated manner, so that all the internal prices and wages go down at once — basically like CPI indexation, only in reverse. (Also, of course, politicians running up high government debts are perfectly happy to drive down the value of the currency so that they can cheat the creditors.)

But the financial benefits to the citizens of a strong currency are so seemingly substantial that you would think that some country — presumably a small, cohesive one like Switzerland, or perhaps Singapore — would figure out a way to do it. There have apparently been a few timid experiments in this direction, which seem to me mainly to evidence a failure of imagination. Surely there ought to be some practicable way to capture the benefit of lowering prices on exported goods without having to cheapen the currency and thereby make everyone in the country pay more for imported goods. I don’t know what it is, but there ought to be a way.

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