Scott Sumner  

Why are so many currencies suddenly appreciating all over the world?

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Many readers might be confused by the title of this post. Haven't we been reading about a currency war? Aren't competitive devaluations occurring one after another, all over the world?

The answer is no, for a very simple reason---it's impossible. All exchange rates are two sided, which means the net amount of devaluation and revaluation on any given day, week, month or year is exactly equal. There can never be net overall devaluation or revaluation occurring in the world's forex markets.

Suppose there are 100 currencies. In that case there are approximately 100 squared, or 10,000 bilateral exchange rates. But if we ignore the 100 that are exchange rates with themselves, we have 9900 actual bilateral exchange rates. And each change is a depreciation in one direction and an appreciation in the other. If the yuan price of euros rises, then the euro price of yuan falls. So I can say with confidence that every single day 4950 currencies will appreciate in the bilateral exchange rate, and 4950 would depreciate (assuming each exchange rate changes by at least a tiny bit--some might not change at all.)

However there are other ways to define the value of a currency. For instance, you could look at its purchasing power over commodities. By that definition most of the world's key currencies have been appreciating in recent month, including the Chinese yuan. That's just another way of saying that commodity prices have been plunging. The title of this post reflects the fact that it's meaningless to make generalizations about which way exchange rates are moving in the world as a whole, and hence any generalizations about the world's currencies must involve some other measure like commodities, to be meaningful at all.

The "never reason from a price change" maxim tells us that lower commodity prices could reflect increased supply or reduced demand. My hunch is that its a bit of both, but the very recent plunge in so many commodities is more likely demand driven, as supply side improvements like fracking rarely impact lots of commodity markets at the same time.

China is by far the biggest consumer of many key commodities, and this suggests the Chinese economy is slowing, probably due to tight money policies, although also partly due to things like the crackdown on corruption, which makes local officials more cautious about green-lighting new projects.

China needs easier money, as does Japan, the eurozone, the US, Sweden, and lots of other places. I guess I'm beginning to sound like a broken record. When was the last time in world history that naysayers who sounded like broken records were, in retrospect, correct? The Great Inflation. And the time before that? The Great Depression. So every few decades the world goes into a prolonged period where its central banks get it wrong in the same direction, for many years in a row. We are in one of those periods now.

COMMENTS (7 to date)
EB writes:

Today you are right about exchange rates. But you are wrong about commodity prices because every minute relative prices of commodities are changing and none can define a unique relevant index of commodity prices. In the old debate about LA inflation in the 1960s, Julio Olivera used to argue that most changes in relative prices took place only through increases in some nominal prices (a view that could be supported by the pervasiveness of government control of many prices during GD, WWII and post-WWII) and that often discretionary changes in controlled nominal prices were accompanied by increases in the quantity of money to facilitate the adjustment (you may remember Larry Sjaastad; when in LA, Larry liked to discuss how large a change in the nominal price of X was necessary to achieve a predetermined change in some relative price of X). Thus, your reference to a very recent plunge on many commodities is wrong because relative prices have been changing in so many ways that none can point to a particular direction (I live in Chile and I'm sure if you asked a thousand Chileans how the purchasing power of the Chilean peso has changed in the past 6 months, at least a fifth of them would say that has increased but hardly more than one third). In the past 50 years, I have learnt that it doesn't matter how much I'd like to aggregate because it is hard to find two alike (both commodities and people).

I spent three years in China (starting on January 1, 1994, the day in which the old system of two currencies was eliminated and the yuan was devalued sharply) and from my work there I learnt that China would never need "easier money". At least then there were too many ways in which many people could create money (or if you prefer, to bypass PBC restrictions that would pose an existential risk to their business as managers of state assets), and even if PBC control had improved sharply in the past 20 years, I'd bet that a lot still can do it. Never reason from a small-country macro model to explain what happens in China--it is an XX-large country with an X-large government.

Floccina writes:

Thanks Scott, I love these more purely educational posts.
Pardon my ignorance but: How did China devalue? Did they buy their own bonds? Did they buy USA treasuries? Did they buy other assets?
I was asked yesterday I was unsure.

Scott Sumner writes:

EB, The fact that people can "create money" (actually money substitutes) has no bearing on whether there can ever be a situation where there is excessively tight money. Tight money occurs when NGDP growth falls at an excessive rate. That may or may not be happening in China today, but it certainly could happen.

I'm not sure what your comments on Chile have to do with this post, I certainly never denied that individual commodity prices move around for all sorts of reasons. But I am focused on the price of commodities in terms of the major currencies, which are trending downward.

Floccina, They offer to buy and sell the currency at the new desired rate. I don't know whether they had to buy any bonds to make the new rate stick. In the long run, a devalued currency requires an increase in the money stock.

Greg G writes:

Thanks for a great question Floccina. I wondered the same thing but hesitated to show my ignorance by asking. And thanks Scott for a very clear answer.

awp writes:

"They offer to buy and sell the currency at the new desired rate."

Did they actively devalue their currency in this manner?


Did they just stop support the higher price in the face of lower demand for Yuan?

Andrew_FL writes:

In other words, there's devaluation in a relative sense (relative to other currencies) and devaluation in an absolute sense (relative to things that aren't currencies). All currencies cannot devalue in a relative sense simultaneously-there will always be as many relative revaluations as relative devaluations by definition.

Isn't this one of many reasons why it is wrongheaded to think of monetary policy in terms of the relative (exchange) value of a country's currency?

EB writes:

Scott, thanks for your reply. Some additional comments:

1. You refer now to the price of commodities in terms of major currencies which are trending downward. I have not checked this idea for a narrow definition of commodities (in the post clearly you use commodities in the broad sense of anything that have value of exchange), but you may be right depending on what you call major currencies. Indeed, if it were a fact (I have not checked the data of Bloomberg or any other source), I'd say it is not a surprise that the price of each "Bloomberg" commodity in terms of each "Bloomberg" major currency has been declining from its extraordinary record level of 2004-2008. I know how those record levels conditioned the economies of all LA countries in the past 12 years.

2. I don't agree with your statement "Tight money occurs when NGDP growth falls at an excessive rate". It'd take too long to argue against it, but certainly experiences of ending hyperinflation and accelerating inflation are exceptions to your idea. Last night I read again your paper on nominal GDP targeting in Cato Journal and I couldn't find any support for your idea of tight money (please let me know about any other paper you may have on this issue).

3. Although the idea of currency substitutes can be applied to China, bypassing PBC restrictions on state banks and state enterprises is specific to China. A detailed description of how the China's payment and banking systems have been changing in the past 30 years is a prerequisite to understand how our Western theories and models have to be adjusted to explain how those systems have been performing.

4. It is my understanding that PBC has continued controlling the foreign exchange market as it did after the reform of January 1, 1994, so it should have no major problem in implementing the devaluation. It seems that in China black markets have not been a problem, as they are today in Argentina and Venezuela.

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