Steve Johnson and Andrew Whiffin
Standard economic theory and common sense are not always aligned, but for once they are when they suggest people should buy more of (most) goods and services when they become cheaper.
Hence a weaker currency should, all things being equal, enable a country to increase its exports. This is the logic of the so-called “currency war”, in which states seek to benefit by letting their currencies weaken, or by actively devaluing them, in a beggar-thy-neighbour approach to steal business from others.
But there are signs this relationship is breaking down, negating the benefits of a competitive devaluation but also robbing genuinely struggling economies of a key plank of the adjustment process that could help them recover.
A recent study by the World Bank, based on analysis of 46 developed and emerging economies, found that between 2004 and 2012 currency depreciations were only half as effective in boosting exports as they had been between 1996 and 2003. But it did still find a weaker currency was of some benefit in this regard.
However, fresh analysis focused purely on emerging markets, conducted by EM Squared, suggests this benefit may have evaporated entirely.
We looked at the movements of 107 emerging market currencies during 2013, 2014 and so far this year. We then mapped that against either real or forecast growth in the volume of exports for the following year, based on data from the International Monetary Fund.
We chose the following year on the basis that there was likely to be a time lag between a currency weakening and a subsequent pick-up in exports. Introducing a time lag also makes it clear as to which way causality is running; if the data were for the same time period a decline in exports could be the reason that a currency is weakening.
We chose to base the analysis on export volumes, rather than dollar values, to avoid the findings being skewed by the sharp falls in oil and other commodity prices witnessed in recent years.
Chart 1, showing the relationship between exchange rate movements in 2013 and exports in 2014 found no statistical relationship between the two — a weaker currency did not deliver any increase in export volumes the following year.
Comparing currencies in 2014 with exports this year (a mixture of real data and IMF forecasts) delivers an even more confounding result, as chart 2 shows. The upward sloping line of best fit suggests, if anything, that currency weakness leads to declines in exports (the biggest devaluations are to the left).
Admittedly this chart is distorted by outliers such as Russia, Venezuela and Ukraine. The first two of these would have struggled to increase exports of their prime product, oil, given soft demand growth, but as we are measuring volumes, not value, a sharp decline is also not merited. Ukraine has of course suffered from extreme instability, which will have weakened both its currency and its export potential.
But even stripping these three out does not show any rise in exports from currency weakness.
Likewise, chart 3, mapping movements in exchange rates this year against IMF forecasts for export growth next year, suggests the fund does not see any read-through at all, with the correlation between the two being zero.
The picture is somewhat different when it comes to imports, an area the World Bank did not analyse.
Here, there appears to be solid evidence that a weaker currency does lead to lower imports (again in volume terms) in the subsequent year.
As chart 4 shows, a 1 per cent currency decline in 2013 typically led to a 0.46 per cent decline in imports in 2014.
Comparing 2014 with 2015 (chart 5) suggests a strengthening of this relationship, with a 1 per cent currency decline prompting a 0.57 per cent slide in imports.
The fly in the ointment is that, on the face of it, the IMF seems to doubt this relationship will continue into next year (chart 6). One possible explanation is that many currencies may have moved significantly since the IMF last updated its forecasts.
The upshot would appear to be that emerging market countries can improve their current account balances by letting their currencies weaken — but only by reducing imports, not by increasing exports.
If so, this would suggest any emerging market currency war is likely to be even more pernicious than thought; its net effect would be to reduce global trade and, quite possibly, economic growth, rather than just reapportioning a fixed level of trade between ”winners” and “losers”.
Neil Shearing, chief emerging markets economist at Capital Economics, sees some truth in this. He argues that after the Asian crises of 1997-98 and the Argentine crisis of 2001-02, “a lot of the adjustment” came through the import side of the balance sheet.
However, David Riley, head of credit strategy at BlueBay Asset Management, offers a potentially more optimistic take, suggesting that “import contraction happens more quickly than growth in exports”, meaning the latter could yet be imminent.
As to why currency weakness appears to be losing its potency, in terms of raising exports, the World Bank suggested a key factor was the growth of global supply chains.
If a country imports many of the parts for the finished goods it exports, then the benefit of the currency depreciation is limited to the proportion of the selling price attributed to the value added domestically, not the whole selling price.
Mr Shearing believes there is “something in the supply chain argument”, but argues exchange rates still have an important role to play in terms of economic rebalancing.
Others point to global demand in aggregate being weak at present, with global trade volumes falling 1.5 per cent in the first quarter of 2015 and 0.5 per cent in the second quarter, according to the Netherlands Bureau for Economic Policy Analysis, keepers of the World Trade Monitor.
This makes it harder for countries to raise their export volumes simply by devaluing their currency.
“The common conclusion is that exports are a lot more sensitive to external demand conditions than they are to sensitive to exchange rates,” says David Lubin, head of emerging markets economics at Citi.
Marc Chandler, global head of currency strategy at Brown Brothers Harriman, who has pointed out that Japan, South Korea, Taiwan, Italy and Germany have all seen exports fall (in value terms) of late despite sharp currency depreciation over the past year, says: “The link between currency and exports has always been a bit stretched in my view. The US Treasury has always said the best thing for US exports is not a weaker dollar, but stronger global demand.”
However this explanation can only go so far. While weak external demand will limit the pick-up in exports from a weaker currency in absolute terms, it should not reduce the relative effect. Those countries that have not seen their currencies weaken should see exports fall more than most in this environment. But the data we have analysed do not show this effect.
The mix of a country’s exports may also be a factor. Mr Lubin argues that the gain in competitiveness from a weaker currency is smaller for countries that primarily export commodities priced in dollars than for those selling manufacturing goods priced in domestic currency.
Despite all this, Mr Shearing detects what he believes may be the early signs of currency weakness feeding through to export growth, in some countries at least.
In Brazil, where the real has suffered a torrid 12 months he says export volumes are now rising at 9 per cent year on year, although import volumes are contracting faster still.
Similarly, Mr Shearing says Mexico has seen a 12.5 per cent year-on-year pick-up in export volumes, no doubt helped by its proximity to the strengthening US economy.
However the picture is patchy, with Asian export volumes falling at 1.5 per cent year on year, despite widespread currency weakness, and the likes of Chile and Peru also in negative territory.
The health of the global economy may well depend on which trend prevails.