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Thursday, June 07, 2018

Currency devaluations alone do not magically provide growth

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John Maynard Keynes, the renowned British economist, wrote in 1919, “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency.” The quote comes from Keynes’ book ‘The Economic Consequences of the Peace’ – the searing indictment of the vengeful Treaty of Versailles. In April of that year the London newspaper, The Daily Chronicle, and The New York Times (see image above) had published a story from Geneva, in which the author claimed it was based on “authentic notes of an interview with Vladimir Ulianoff Lenin, the high priest of Bolshevism, which were communicated to me by a recent visitor to Moscow.” Ulyanov was Lenin’s family name.

Debauching, devaluing or depreciating a currency is often seen as a relatively painless adjustment to improve the competitiveness of exports. However, it can also reflect endemic economic failure. In early 2013 Bloomberg reported: “Venezuelans lined up to purchase airline tickets and TVs this weekend in a bid to protect themselves from price increases after ailing President Hugo Chávez devalued the bolivar for a fifth time in nine years.”  Five years later The Economist reported: “A monthly mobile-phone tariff is 38,000 bolívars or 15 cents; a haircut is 25 cents. Wages tend to lag behind prices, in large part because it is so hard to keep up with them. The monthly minimum wage has just been raised for the umpteenth time, to around 800,000 bolívars.”

The big falls in recent years in the value of the pound sterling and the Japanese yen suggest that devaluations have lost their economic firepower:

1) A 10% fall in the value of a nation’s currency can boost exports of traditional traded goods by an average 1.5% of GDP, according to a study by the International Monetary Fund;

2) The IMF says “Whether or not a devaluation is successful depends…largely on the extent to which it is supported by strong conditions and policies, including a favorable external environment, a healthy financial system that can support credit growth, tight incomes policies to control inflation and a successful scale-up of investment”;

3) About 60% of Britsh goods exports are components shipped into international supply chains. A falling pound can raise their costs; where quality is more important than price, such as with pharmaceuticals, a change in the currency rate may not be important;

4) The UK government says "Based on available data it is estimated that 9% of the UK's SMEs export and a further 15% are in the supply chains of other businesses that export." These SMEs typically would also supply to the domestic market while the prices of foreign imports would rise.

5) A February 2018 paper by Pantheon Macroeconomics shows that over the previous eight quarters research shows that net trade (exports less imports) had contributed just 0.2 percentage points to 3.3% growth in GDP.

6) Many UK exporters have not passed on the price gain from a falling pound. Business investment shrank by 0.2% during the first quarter of 2018, while household spending only rose by 0.2% — the weakest reading in over three years. Business is building up profits while investment has stalled, because of the Brexit uncertainty;

7) There was an improvement in UK exports in 2017 but the world economy was performing well. When Britain crashed out of the European Exchange Rate Mechanism in 1992 and achieved small goods trade surpluses until 1998, there had also been a big boost from falling interest rates.

8) A 2015 Bank of England paper says “Different types of shocks causing an appreciation (or depreciation) could have different effects on the economy — even if the shocks are scaled to generate an equivalent currency movement.”

9) In late 2012 Shinzo Abe became the Japanese prime minister for the second time. Even during a severe recession from 2008, the yen was rising partly because of its safe-haven status but also from an unwinding of the so-called yen carry trade where high overseas interest rates had prompted outflows during the boom years. An estimated $15tn in personal savings had been built up through persistent trade surpluses and Japan had become a provider of low-cost capital for the rest of the world.

10) Massive quantitative easing pushed down the value of the yen. The economy remains weak but it is no longer in deflation and there was a case for pushing down the overvalued rate. The Japanese government has also put in place a programme of reforms.

Japan’s inbound tourism is one big success of what is called Abenomics. Propelled by visa-rule deregulation, inbound tourist arrivals have risen almost fourfold, from a 2012 monthly average of 697,000 to 2.6m recently.

Italy

Last weekend, David McWilliams wrote in The Irish Times “Italian competitiveness has been decimated by the euro. Without devaluations, Italian industry has floundered. Either a country’s currency adjusts if it is not as competitive as its neighbour, or it goes out of business. Italy is gradually going out of business“ — but the remedy of repeated devaluations, without addressing big annual budget deficits and a massive jump in public debt, is akin to a doctor giving a patient medicine to alleviate symptoms while doing nothing about the patient’s disease. Economic research shows that a 53% fall in the value of the Lira against the German Mark in 1979-1999, had no impact on Italian employment. See Irish Times article + comments here.

In Italy, the temptation to go back in time, or shut the door to Europe and globalisation is strong, especially after a quarter of a century of poor economic performance, argue Lorenzo Codogno and Giampaolo Gallifull post here.

As to the poor economic performance, Italy’s per capita GDP stands at 106 if we put 1995 equal to 100, which means that Italy has barely grown over almost a quarter of a century. All the other OECD countries have done better, including the wretched Greece that stands at 116. The Eurozone without Italy stands at 135, which corresponds to average annual growth of 1.4% over 1995-2017, broadly the same growth recorded in the United States. Among the other major countries, Japan was second only to Italy, but it still managed to be at 119. Thanks to a group of excellent companies, a strong export sector, and the policies introduced in recent years, the economy started to grow again in 2014, but Italy is one of the very few OECD countries that have not yet managed to recover to pre-crisis levels. To date, GDP per capita has contracted by 8.2% compared to 2007. Almost all other countries have largely exceeded pre-crisis levels. The Eurozone net of Italy stands at 5.0 percentage points above pre-crisis levels, the United States at 6.4 points. In each of the years between 2015 and 2017, Italy recorded GDP growth about one percentage point below the other Eurozone countries. Moreover, Italy’s regional divide is huge and has not narrowed in recent years.

Three other Italian economists produced research which showed that the euro did not make Italy’s economy worse.

Italy and the euro: Myths and realities

The annual cost of servicing the national debt fell from about 12% of GDP in the early 1990s to under 4% in 2017, but the savings were not used to pay down debt that has grown to 132% of GDP.

 Finfacts: Italy- A century of annual budget deficits and high public debt