How to read a currency devaluation

In August, 2015, China (amongst other countries) pursued a currency devaluation.

Any such move on the part of any national central bank is purely political but the economic repercussions are as well understood as the effect of an earthquake.

The political ramifications will take longer to understand as to whether there is a concerted central bank game being played between the People's Bank of China, the Federal Reserve, the Bank of Japan, the European Central Bank and the Bank of England. 

Following the 2007 'credit crunch' the Federal Reserve Bank has been on a quantitative easing 'spending spree': the money supply in the US has quadrupled since around the time Obama took office but its effects are yet to fully play out. The Banks of Japan and England soon followed suit and since then there have been further apparently uncoordinated moves to devalue currencies with the PBofChina being the most recent member to join in what James Rickards calls a new currency war. 

Regardless of the machinations behind the scenes (hopefully some journalists are clocking the stories), the economics of a currency devaluation are relatively simple. 

When a nation devalues its currency, it makes it cheaper to purchase abroad. This can encourage (all things being equal of course) an uptake in the country's exports, which makes the export sector look good and healthy. However, it also makes the country's imports more expensive: that implies that people are going to have to pay more for imported goods and services than they used to purchase prior the devaluation. 

To some extent, the overall effect of the devaluation would seem to hinge on the extent to which growth is dependent on exporters...but if the exporters in turn are purchasers of raw material inputs or services, then the result would seem to be a zero-sum solution.

However, even if a country has a strong export market from home grown produce and the devaluation creates a boom for its sales, devaluations have a tendency to come back and hit hard. 

Currency devaluation effectively is the same as pursing an inflationary policy: new money is released into the economy, some of which is destined for the for-ex markets where the devaluation takes place, but some of it will enter the domestic market and chase up prices somewhere or other. 

Why the vagueness of 'somewhere or other'? While statisticians like to play with indices, the real action takes place in real markets - and where the monies will be spent is not something we can predict with any great accuracy. Generally speaking, new monies tend to enter the banking system at some point which will depress nominal interest rates and usually cause an upsurge in borrowing for projects that would not otherwise get off the ground: ultimately, this will end in tears when the interest rates bounce back up.

And bounce back up they inevitably have to: when new money is released into the economy, it creates interest rate and price distortions...but gradually and inexorably, prices (the cost of living) will rise to reflect the greater quantity of currency circulating, which in turn will put pressure on interest rates to rise. 

The inevitable can only be put off. And that's the game the central banks are currently playing. By devaluing (following a policy of deflation) they are building up trouble for the future. In the meantime, the devaluation will hurt many people's wealth - those on fixed incomes and those who do not enjoy a rise in wages until long after the cost of living has risen: basically, some people will become richer by riding what I call 'the inflationary wave' of cheaper credit or new money, but most will be impoverished.

Politically though, a devaluation tends to be contagious. Politicians react and then tell the central bankers to react: if China devalues to sell more of its goods to the US, then the US will retaliate and devalue the dollar to match the Chinese move...and then China will respond again with another devaluation. From a superficial standpoint, the relative currencies may remain somewhat equal in this crazy dance...but when the currencies are compared to the price of real estate or gold and silver, the effects become glaringly obvious.