The euro is in trouble. That is not news. What is news is that people with deep pockets are willing to pay for economists to provide a solution. Lord Wolfson, CEO of European retailer Next Retail Ltd, has offered a £250,000 prize for the best way a country can exit the European Monetary Union (EMU). Five finalists for the prize were announced in March. The winner is to be announced in June.
None of the five finalists — Neil Record, Jens Nordvig, Jonathan Tepper, Catherine Dobbs, and Roger Bootle — advocates a return to sound money; all assume that new, national fiat currencies will float; and all assume that unproductive countries will benefit from devalued new currencies.
The theory is that a devalued currency will spur export-driven economic growth. Furthermore, they have little confidence that economic reforms — which they all, by the way, do recommend — will be achieved in the near term and see devaluation as a quicker alternative. But will this work? First a word about devaluation itself.
Devaluing Against Gold
Historically, devaluation of a currency referred to its relationship to gold. Gold could not be expanded in any appreciable amounts very quickly. It had to be dug up, minted, and placed into circulation at some expense over a long period of time. Coin clipping and substituting a base metal for some percentage of the gold in coins were early means of money debasement. Later, paper currencies could be expanded as quickly and as cheaply as the mint could run paper through its presses, but even this pales in comparison to these electronic times in which money can be expanded to any amount desired at the click of a mouse.
Devaluations occurred, of course, even when governments admitted that gold was money. Notable examples are the Swiss devaluation in 1936, detailed so succinctly by Ludwig von Mises in Human Action, and America's shocking 69 percent devaluation in 1934. Both of these, and others like them, were considered shameful and self-serving acts. Devaluation was tantamount to an admission of fraud. The country's central bank had printed and circulated more units of currency than it could redeem at the currency-to-gold price it had promised its trading partners. This, of course, had disastrous effects on everyone who held contractual promises to be paid in gold.
Devaluing Against Currencies
The devaluation advocated by many economists today is quite different in one regard. There is no commodity reserve — gold or silver, for example — against which the nation's currency is to be devalued. Modern devaluation advocates refer to the currency's value, or exchange ratio, in relation to all other fiat currencies. The exchange value between currencies is governed by purchasing-power parity, which is the simple comparison of the price levels of two countries as expressed in local currency.
Nevertheless, the mechanism for devaluing is still the same as that which occurred under gold: inflation of the fiat-money supply. For example, the central bank could give foreign buyers more local currency with which to buy local goods. This increased supply of local currency eventually works its way through the economy, raising all prices. Economists refer to this process as "importing inflation." The devaluation advocates attempt to convince their countrymen that what was once a shameful act is now a positive good. For example, the Swiss are trying to lower the value of their currency in relation to all others.
What of the proposition that taking positive steps to devalue one's own currency against all others, if it can be achieved, will actually help a country become more competitive? What have others said on this subject?
Insights from Kant, Bastiat, Hazlitt
A policy of currency devaluation can be judged by whether or not it satisfies Immanuel Kant's "categorical imperative," which asks whether the action will benefit all men, at all places, and at all times. Certainly a devaluation will benefit exporters, who can expect to make more sales. Their foreign customers get more local currency in exchange for their own. Exports increase. The exporter's position is one that is best examined by considering Frederic Bastiat's brilliant essay "That Which Is Seen, and That Which Is Not Seen," and "The Lesson" found in Henry Hazlitt's Economics in One Lesson.
At the instance of exchanging his money for more local currency, the foreign buyer will indeed be inclined to purchase more of the goods from the country that devalued. This we can see, and most pundits consider it a good thing. The exporter's increased sales can be measured. This is seen. But what about the importer's lost sales? Importers can expect the opposite. The local currency will buy less, and they can expect sales to fall due to the necessity of raising prices to reflect the reduced purchasing power of their local currency. How can one measure sales that never happened? This is Bastiat's unsee