On boards discussing economic matters I frequently read opinions expressing gratitude that the poster's currency has been devalued. It seems almost to be regarded as a universal good, a manoeuvre that every country would engage in as frequently as possible were it not for fear of tit-for-tat reprisals from other nations.
The key advantage, we're assured, is that it makes exports more competitive. If the US dollar is devalued, US goods will be cheaper, so more of them will be sold, increasing profits and boosting jobs. Champagne all around.
Yet if this chain of events represented such an unalloyed cause for celebration, each poster backing devaluation ought to be equally pleased if their boss were to announce a 5% cut in everybody's wages at their workplace on Monday morning. After all, the effects are equivalent: the wage costs are reduced, so the prices of the goods can be reduced. The company becomes more competitive, sells more goods and can stave off redundancies and/or expand its workforce. The only downside for each worker is the minor one of being paid less.
And being paid less is exactly what happens when your nominal wages stay the same but the currency is devalued. When sterling lost around a quarter of its real value over the course of the last three years, everyone on fixed wages in the UK took a 25% pay cut. Most of them simply didn't realize it.
Of course, it's slightly more complex than that. If a country's currency is devalued rapidly, some domestic prices will stay the same – nominally - for a while. I'm being paid 25% less, but so is Smith the baker, and Smith is charging 25% less – in real terms – for his bread, at least for now. But the cost of imports will rise, affecting many domestic prices, so in due course most people will start to feel as though they've each had a pay cut – which they have.
Our general inability to think of things in real terms (as opposed to nominal terms) is one of the reasons why devaluation is such a useful tool for business. It allows people to be given gradual real pay cuts (simply by not increasing their nominal salary over a period of time) without them complaining about it, whereas almost everybody would complain if a nominal pay cut were imposed upon them while the currency stayed stable. The two are broadly equivalent, but our brains just don't tend to work that way. And sometimes the ability to reduce your workers' wages is vital to keep your company in business. As for an individual business, so for the country as a whole.
But devaluation is also a useful tool for the financially sophisticated to gain a bigger slice of the pie: if you have the ability to lower the real wages of those around you without them noticing, while your real wages stay the same, you can outbid them for real assets and cement your economic (and perhaps political) control. Whilst we can each take refuge in defensive assets so that our savings resist the ravages of inflation, most of us have no direct or rapid control of our level of nominal income. Our incomes will probably move up to counterbalance currency devaluation given a little time, but in the meantime those who can boost their incomes immediately can take advantage of the lag. This is an example of the Cantillon Effect, whereby those who are closest to the source of a recent money supply expansion gain a significant advantage in buying up the real wealth in the economy.
So remember: every time you hear that your currency's value is dropping, and you listen to the celebratory voices of many of those in the business community, keep in mind the fact that you've just been handed a pay cut.
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