Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
USDT Ponzi Scheme FINAL WARNING To EXIT Before Tether Collapses Crypto Exchange Markets - 22nd Jun 21
Stock Market Correction Starting - 22nd Jun 21
This Green SuperFuel Could Change Everything For the $14 Trillion Shipping Industry - 22nd Jun 21
Virgin Media Fibre Broadband Installation - What to Expect, Quality of Wiring, Service etc. - 21st Jun 21
Feel the Inflationary Heartbeat - 21st Jun 21
The Green Superfuel That Could Disrupt Global Energy Markers - 21st Jun 21
How Binance SCAMs Crypto Traders with UP DOWN Coins, Futures, Options and Leverage - Don't Get Bogdanoffed! - 20th Jun 21
Smart Money Accumulating Physical Silver Ahead Of New Basel III Regulations And Price Explosion To $44 - 20th Jun 21
Rambling Fed Triggers Gold/Silver Correction: Are Investors Being Duped? - 20th Jun 21
Gold: The Fed Wreaked Havoc on the Precious Metals - 20th Jun 21
Investing in the Tulip Crypto Mania 2021 - 19th Jun 21
Here’s Why Historic US Housing Market Boom Can Continue - 19th Jun 21
Cryptos: What the "Bizarre" World of Non-Fungible Tokens May Be Signaling - 19th Jun 21
Hyperinflationary Expectations: Reflections on Cryptocurrency and the Markets - 19th Jun 21
Gold Prices Investors beat Central Banks and Jewelry, as having the most Impact - 18th Jun 21
Has the Dust Settled After Fed Day? Not Just Yet - 18th Jun 21
Gold Asks: Will the Economic Boom Continue? - 18th Jun 21
STABLE COINS PONZI Crypto SCAM WARNING! Iron Titan CRASH to ZERO! Exit USDT While You Can! - 18th Jun 21
FOMC Surprise Takeaways - 18th Jun 21
Youtube Upload Stuck at 0% QUICK FIXES Solutions Tutorial - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations Video - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations and Trend Analysis into Market Correction - 17th Jun 21
Stocks, Gold, Silver Markets Inflation Tipping Point - 17th Jun 21
Letting Yourself Relax with Activities That You Might Not Have Considered - 17th Jun 21
The Federal Reserve and Inflation - 16th Jun 21
Inflation Soars 5%! Will Gold Skyrocket? - 16th Jun 21
Stock Market Sentiment Speaks: Inflation Is For Fools - 16th Jun 21
Four News Events That Could Drive Gold Bullion Demand - 16th Jun 21
5 ways that crypto is changing the face of online casinos - 16th Jun 21
Transitory Inflation Debate - 15th Jun 21
USDX: The Cleanest Shirt Among the Dirty Laundry - 15th Jun 21
Inflation and Stock Market SPX Record Highs. PPI, FOMC Meeting in Focus - 15th Jun 21
Stock Market SPX 4310 Right Around the Corner! - 15th Jun 21
AI Stocks Strength vs Weakness - Why Selling Google or Facebook is a Big Mistake! - 14th Jun 21
The Bitcoin Crime Wave Hits - 14th Jun 21
Gold Time for Consolidation and Lower Volatility - 14th Jun 21
More Banks & Investors Are NOT Believing Fed Propaganda - 14th Jun 21
Market Inflation Bets – Squaring or Not - 14th Jun 21
Is Gold Really an Inflation Hedge? - 14th Jun 21
The FED Holds the Market. How Long Will It Last? - 14th Jun 21
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Currency Wars, Devaluations Have Real Effects

Currencies / Fiat Currency Nov 15, 2010 - 08:54 AM GMT

By: Robert_Murphy


Best Financial Markets Analysis ArticleWhen my book on the Great Depression came out — shortly after Obama's inauguration — I told radio interviewers that our current economic crisis was the start of the Second Great Depression. The Federal Reserve and the government implemented the same types of policies after the housing crash as they did in the 1930s after the stock-market crash.

Another parallel to the Great Depression is the possibility of a massive trade war. Back then, the United States government passed the infamous Smoot-Hawley Tariff, which in turn led to reciprocal trade barriers by other governments.

In our own time, US officials have pressured the Chinese to allow their currency to appreciate against the dollar. More recently, Europeans have complained about the Federal Reserve's plans for a second round of "quantitative easing" because of the advantage a weaker dollar gives to US exporters. Over the next few years, we may be in store for currency wars, in which nations continually print money in order to gain a temporary trade advantage. The end result, of course, will be accelerating price inflation and distorted production across the globe.

Weak Currencies and Strong Exports

To the novice, a "strong currency" sounds like an unambiguous good. But a firm that exports its products may actually benefit, at least in the short run, from a currency that becomes weaker against other currencies.

For example, suppose we are in an initial equilibrium where €1 (i.e., one euro) trades for $1, and the price of a bushel of wheat is $5 and also €5. Then the Federal Reserve announces that it intends to double the quantity of US dollars in one month.

The announcement would lead to an immediate drop of the dollar in the foreign-exchange markets. In other words, the currency speculators who traded dollars against euros would anticipate the coming flood of new dollars and would bid down their price accordingly. Suppose the "dollar price" of a euro rose from $1 to $2 because of the Fed's bombshell announcement.

This new situation would help American farmers but hurt European farmers, at least temporarily. At the old price structure of wheat — where a bushel cost $5 if purchased from an American farmer or €5 from a European — the suddenly weakened dollar would give a tremendous advantage to American farmers. Because €1 would now trade for $2, the American farmers would effectively be selling bushels of wheat at half the price of their European counterparts. The fall in the dollar's exchange rate against the euro would have instantly rendered American exports that much cheaper and (what is the same thing) rendered European exports that much more expensive.

Consider things from the perspective of a United States–based miller. He could continue to buy wheat grown by his fellow American farmers at $5 per bushel, just as before. But if he wanted to import wheat grown in Europe — where it was still selling at €5 per bushel — now he would need to cough up $10 per bushel. This is because his $10 would be converted on the foreign-exchange market into €5, which could then be used to buy a bushel of wheat from a European farmer. Clearly, United States–based millers would switch their business to American farmers and wouldn't import any wheat from Europe.

The situation would be reversed for millers based in Europe. After the Fed's announcement, the euro would suddenly become twice as strong as the dollar. To buy $5 wheat from American farmers would take only €2.50 per bushel, as opposed to the €5 per bushel from European farmers. Obviously the millers in Europe would have an incentive to switch their business from European to American farmers.

In reality, it's not the case that suddenly American wheat farmers supply the whole world, and everyone else goes out of business. Instead, what happens is that the price of wheat — quoted in various currencies — itself adjusts very quickly when the dollar falls against other currencies. In our example, when currency speculators are pushing the euro from $1 to $2 (because of the Fed announcement), speculators in the agricultural markets push wheat up to (say) $8 per bushel, and down to €4 per bushel. In order to eliminate arbitrage opportunities, a new equilibrium will quickly arise in which wheat is the same price, whether quoted in dollars or euros, at the new exchange rate of $2 for €1.

Devaluations Have Real Effects

At this point, it's tempting to think that the Fed's announcement would have no effect on the pattern of global production and trade, and that it would merely tinker with nominal price tags. But this isn't the case. Because domestic prices have various degrees of flexibility, the devaluation of the dollar in our example would give more than a fleeting advantage to American exporters.

Consider the wheat farmers: After the speculators quickly respond to the Fed's announcement, the price of wheat rises from $5 to $8 per bushel. It's certainly not that the wages of the employees working on the farm, or the mortgage payments made to the bank, will jump by a comparable percentage in a few moments. On the contrary, much of the American farmer's expenses will remain fixed in price even though the sale price of wheat has risen 60 percent. American wheat farmers will therefore find the dollar devaluation to be very lucrative. From their perspective, it will appear as if millers (both domestic and foreign) for some reason have a hankering for American wheat, and the American farmers will increase their output to satisfy the new demand.

Things are the opposite for the European farmers. The demand for their product will collapse, such that the new equilibrium price falls to €4 from its original level of €5. This 20 percent drop in price cannot be simply "passed on" to workers, who have labor contracts specifying how many euros per hour they must be paid. Consequently, European farmers will scale back their production of wheat.

In the grand scheme of things, the Fed's announcement of its plans to print more dollars will allow American wheat farmers (and other exporters of fungible commodities) to gain market share at the expense of farmers in other countries, whose currencies appreciate against the dollar. This is why Keynesian economists stress the (alleged) virtue of weakening a currency in order to "stimulate exports" and hence boost national output — net exports are a component of GDP in the standard formula.

The Unseen Consequences

As Bastiat taught, the good economist must look at the unseen consequences of a government (or central-bank) policy. Just because American wheat farmers gain a definite advantage from currency debasement doesn't mean it is a good idea.

In our example, American consumers are hurt by the depreciation. Wheat is now more expensive than before. If the consumers buy domestically, they must pay $8 instead of $5. Yet even if they buy from European farmers, they still must pay more, because of the change in exchange rate. (Specifically, it takes $8 to buy €4 with which they can purchase a bushel of wheat.) The same is true for other fungible goods that trade on the world market: their dollar prices rise, and their euro-denominated prices do not fall enough, such that the goods end up being more expensive.

Another group hurt by the announcement are those American producers who sell domestically but import materials. For example, US airlines would be hurt because the price of crude oil would rise sharply with the Fed announcement.

It's true that, eventually, the Fed would create the new dollars, and these would eventually ripple out into the pockets of American consumers and airline shareholders. But by that point, the damage will have been done. The Fed's decision to double the quantity of dollars will have constituted a transfer of wealth from American consumers and importing firms into the pockets of American exporters. The debasement wouldn't have made Americans on net richer; it simply would have rearranged wealth and distorted production decisions.

Currency Wars

There is another danger with our hypothetical Fed decision: other central banks might just reciprocate. In our example above, the European Central Bank (ECB), upon hearing the Fed's announcement, could make a similar pledge to debase the euro. If the ECB officials picked their numbers just right, speculators would then enter the currency markets and push the euro back down to $1.

Yet this wouldn't return things to the way they were. On the contrary, there would now be twice as many dollars, and twice as many euros, as before — even though the same physical quantity of wheat would be harvested.[1] Therefore the nominal price of wheat would be permanently higher, quoted in either currency. Using our numbers, after the ECB announcement, speculators would push wheat down from $8 to (say) $6 per bushel and up from €4 to €6. Recall that this is higher than the original prices of $5 and €5 for a bushel of wheat.


When governments try to confer an advantage to their exporters through currency depreciation, they risk a war of debasement. In such a race to the bottom, none of the participants can gain a lasting competitive edge. The lasting result is simply weaker and weaker currencies against all goods and services — meaning higher and higher prices. Inflationary policies do not confer lasting advantages but instead make it more difficult to plan for the future. Stop-and-go inflationary policies actually reduce the benefits of using money in the first place.

Robert Murphy, an adjunct scholar of the Mises Institute and a faculty member of the Mises University, runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal. Send him mail. See Robert P. Murphy's article archives. Comment on the blog.

© 2010 Copyright Robert Murphy - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in