Regards from sunny Barbados.
A recent article that has made the rounds of the financial pages of many newspapers is that the US is taking steps, along with other nations, to increase the value of the Chinese currency in terms of other hard currencies (US dollar, Euro, etc.). China has notoriously kept the value of its currency low so that its goods, in relation to other currencies, can be imported at low cost to the buyer. We in Canada should know all about that. When our dollar was about 75 cents US, exporters basked in the glow in what amounted to a 25% subsidy of Canadian prices.
To most people the wax and wane of money on the international market is either of no consequence (unless you are shopping in the US) or is so complex that eyes glaze over and yawns are hardly stifled when the subject is brought up. This post hopes to be a "guide to the perplexed". So stifle your yawn.
We all know that money is a medium of exchange. If I have too many chickens and you have too many goats for our own consumption the only way we can trade is if we find a common denominator to value our goods, I price my chickens in terms of that denominator and you price your goats in terms of that denominator and we trade. The denominator is the local currency. This currency can be as common as shells or as strictly controlled as government controlled paper currency. So long as the supply of that currency is stable (no counterfeiting allowed) prices will remain stable. Happily I will not write about what happens when the currency supply becomes unstable--like inflation. Maybe for another post.
All of this works well if we are on an island and we all have what we and others on the island needs. Once we trade off the island--that is with someone who has currency other than our own--another set of rules apply. As between our foreign buyer and ourselves we have no common denominator. You will not accept his currency in payment for your products because you cannot spend that currency on your island. Similarly he cannot accept yours if the trade is the other way. Therefore, before a trade can be made, he must first buy your currency and then trade. Money traders have been engaged in this business for centuries. They buy and sell currencies. What the buyer has to take into account is the cost of buying your currency (if it's a one for one trade then no one suffers; if he gets two of your currency for one of his, i.e. your currency is worth half of his, he is (all other things being equal) a big winner). You, as the local seller do not care. You satisfy your needs with your own currency. So, simply stated, the lower the value of your currency in terms of the foreign purchaser's currency the cheaper your goods are in terms of his currency.
So far so good. Let's take chickens. Lets assume your currency is worth half of the foreign buyer's currency. You want to sell your chicken for $10. It will cost the foreign purchaser $5 in his currency to buy the chicken. But if chickens in his country only sell for $3 then its no deal. He then has to buy your currency at a 70% discount to his currency in order to make a trade
But why are your chickens only worth $3 in terms of the foreigner's currency? Perhaps it is because his country raises chickens through mass production and you are still raising chickens on the farm. Therefore, the 70% discount in currencies reflect your inefficiencies in the production of chickens. In that way, relative currencies keep good score between the efficiencies in various economies. For years, the devalued Canadian dollar measured inefficiencies in the Canadian economy vis a vis the US economy. Some will say Canada caught up (though I doubt it) and therefore the US and Canadian dollars are roughly at par.
All this assumes that currencies can be bought and sold on an open market. If a country artificially reduces the value of its currency (how doesn't matter now) it will makes its goods less expensive in terms of other currencies. That is what China is doing. Aside from the low cost of labour and the efficiencies of mass production it is said that China is adding an additional "sale discount" to its goods by artificially keeping its currency low
What to do about it is for another post. Suffice to know just what's happening in the news.
Bernie.
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