by David Moon
Mexico’s peso fell to a new low this past week, drawing warnings of economic malaise from many economists. If a devalued currency is negative for Mexico, why all the fuss and worry about China devaluing its yuan? How does a devalued peso signal troubles in Mexico, but a devalued yuan means troubles in the U.S.?
In just three years, the People’s Bank of China has devalued the Chinese yuan 16 percent against the U.S. dollar, concerning skeptics that the weaker exchange rate will make U.S. goods more expensive in China, placing U.S. international companies at a competitive disadvantage.
That argument is naïve and misguided. Like stock prices, the prices of currencies bounce around in the short-term for a variety of reasons. In the longer-term, however, a currency’s value depends on the underlying economic fundamentals of the country issuing it.
If a country could boost its financial fortunes by devaluing its currency, it’s not just Mexico that would be enjoying an economic boom. Venezuela would be the world’s economic juggernaut. In two years, the bolivar has fallen 96 percent against the U.S. dollar, yet its real GDP has declined almost 10 percent. Venezuelan inflation exceeds 700 percent annually.
Politicians seem solely fixated on the yuan’s exchange rate with the dollar, but every developed country manipulates its currency against something. Countries regularly target their currency values against commodities, other currencies or interest rates.
The U.S. Federal Reserve manages (that is, manipulates) the value of the dollar by changing the Fed Funds rate, attempting to manage the value of the dollar to a target level of domestic inflation. Small, less developed countries peg their currencies to larger, more widely accepted currencies, most often the U.S. dollar.
From 1978 to 2005, China was considered a developing country, lacking the economic foundation to support its currency in the world markets. As a result, the People’s Bank of China pegged the yuan to the dollar, amassing a massive portfolio of U.S. Treasury securities as effective “collateral” against its paper money.
In 2005, China began loosening its peg to the dollar, finally completely abandoning it 2015. Once the world’s largest owner of U.S. Treasury debt, China has been reducing its U.S. holdings since late 2013. It is now the world’s largest producer and importer of gold.
Even the history between the U.S. and China discredits the idea that a weakening currency improves a country’s worldwide competitive situation. When the dollar depreciated 25 percent against the yuan from 2004 to 2014, U.S. companies did not benefit; the U.S. trade deficit with China actually more than doubled in that decade.
There are many ways to make America greater or great again; starting a currency war with China is not one of them.
David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN)