Is a ‘strong’ currency desirable?
Whether a strong currency is good for your country or not is a very common question I encounter when students first start learning about exchange rates and trade.
Anyone new to economics often assumes that a strong currency is desirable. This is understandable but fairly simplistic.
Firstly, the word ‘strong’ sounds good; a ‘strong’ currency must be better than a ‘weak’ one right? Second, when we go abroad on holiday, often are first experience of exchange rates, we like it when are money goes further. Therefore we conclude a strong currency is good; it makes us feel proud about our currency and we get things cheaper when we go abroad. However, we really need to consider more than this to reach a conclusion.
First let’s consider what we mean by a strong currency.
Normally we are referring to an appreciation in the value of currency. That means we can buy more of another currency than we used to be able to.
For example if today I can get $1.6 for £1 and this time next year I can get $2 for £1 then the £ has appreciated. This allows me to buy more when I go on holiday and so forth. But, beyond cheaper holidays is a strong currency really desirable?
It would make sense to consider this in the context of the four macro-economic objectives of government:
Does a strong currency aid Growth?
Most likely the answer is no, a strong currency will limit growth.
There are a number of reasons for this.
1- A strong currency makes it harder for exporting firms to sell their products abroad.
2- Consumers find that buying imported products is cheaper so we either spend more on them and/or we substitute foreign products for domestic ones. Either way there is likely to be a fall in domestic spending.
3- A strong currency may also deter foreign investment.
So not good, what about Inflation?
Does a strong currency reduce the rate of inflation.
On the whole yes, a strong currency reduces inflation rates.
We will import more, export less and experience reduced investment. All of this will limit AD and therefore limit demand pull inflation.
The stronger currency can also reduce cost push inflation. Imported essential products such as energy, food and so forth become cheaper. So that’s nice. What about unemployment?
Does a strong currency reduce unemployment?
Most likely a strong currency will increase unemployment.
If exporters are struggling and we are buying more imports and less domestic products then demand for labour is likely to fall and unemployment is likely to rise.
This sucks, what about Balance of Payments?
Does a strong currency helps us achieve a satisfactory balance of payments?
This depends on what we think is satisfactory, but the strong currencies impact on trade will be to reduce exports and increase imports.
We may also see domestic firms taking advantage or a strong currency to invest abroad and there will also be less investment into the country with the strong currency.
All of this is going to lead to a net increase in debits and fewer credits on the balance of payments. For a country like the UK which has a significant trade deficit this will worsen our balance of payments.
So is a strong currency good or not?
On the basis of the above it becomes increasingly clear that a strong currency generally damages the macro-economic goals of an economy. This is why many countries would prefer a weak currency and why the USA gets upset with China when it thinks China is depreciating the Yuan. This is also one of the reasons why Greece is in such a difficult situation. If Greece had its own currency a variety of factors would have led to a depreciation which would have helped its economic recovery.
However, the above is a very simplistic analysis of whether a strong currency is desirable or not. We really should think more critically. I will try and give a more evaluative analysis tomorrow.