Question

A number of people (including the President) have been concerned about the value of the dollar as it affects our international competitiveness. On the other hand the value of the dollar obviously also affects the purchasing power of American consumers.

In what sense are these interests in conflict? Which is more important?

Answer 1

• We live in a era of globalization where international trade and floating currency exchange rates play a crucial role in the economic performance of any country. Lot of countries (Japan being a prime example) have for a long time been comfortable with devaluation of their currencies in international market.
• The most important and common benefit cited for devaluating currency is the boost to exports. When a country's currency is devalued, it becomes cheaper for customers in other countries to buy its products. E.g.- If USD is devalued, it would become cheaper for Europeans or Indians to import American cars.
• Just like everything has pros and cons, devaluation of currency also has negative impacts on the economy, one of which is that the imports become more expensive, impacting the purchasing power of domestic consumers. A lot of times the majority of country's imports are for goods, services which are of necessity (e.g- Oil, natural gas) & the demand of which can not be domestically met. The demand for such products could be very price inelastic and devaluation of currency can shoot up the import bill
• Similarly, there could be various other benefits of devaluation such as debt repayment becomes cheap, trade deficits could be narrowed, increase in GDP growth through exports when growth is low in domestic economy, improved BOP, etc and various other disadvantages as well, such rapid devaluation could hamper investment in the economy, inflation, etc.
• Clearly, the above mentioned advantages and disadvantages are in conflict with one another. Whether it's a good policy to devalue currency or not is completely dependent on the existing economic situation at the time. In no ways, one of the two is always better than the other. Some of the relevant factors may include:
  • Existing economic situation
  • Nature of country's imports
  • Existing inflation levels
  • Existing investor sentiments and outlook
  • Sectors/industries that are primarily involved in exports and imports
  • Opportunities available for exploiting growth through exports
• Different policies would work in different times/economic scenarios and all situations must be analyzed independently.