The Lies of Devaluation and Why PMB Must be Supported

How many times will I try explaining to all these Bad Samaritan economist that Devaluation is bad for Nigeria and any economy in the time of contraction in growth? Right now, Nigerian revenue y/y is down by about 50%; GEJ and the PDP did not save a penny for 6 years and squandered the about $55billion of Excess Crude Account and External Foreign Reserves that  Yar’Adua left even when crude sold for an average of $105/Barrel for the disastrous GEJ years.  There are many historical examples, stretching at least to the Great Depression, which show currency devaluations tend to go hand-in-hand with economic turmoil.  Out of about 48 devaluations that took place during the Bretton Woods era; on balance, they were mostly not successful. We also have recent devaluation efforts of the US, UK, Russia and the recently celebrated China’s attempt to use devaluation to stimulate exports, neither of which has spurred economic growth.

The main problem is that devaluation robs citizens of their purchasing power. If the Nigerian government devalued the Naira again today, for example, it would reduce the value of each and every Naira earned by Nigerian workers and every Naira saved by all Nigerians. There’s more to this story, as noted above, but it’s generally not a good idea to make people poorer. To see exactly how devaluation might take place, it’s helpful to look at what happens to the relative value of currencies, or exchange rates. Assume that a Nigerian can use 200 Naira of get 1 U.S. dollar today. Then, for whatever reason, the situation changes so that we have to use 250 to get $1 officially (The Speculative Black market is being influenced by these Criminal Speculators whose only interest is short term gains and any-ways, no country in the world uses the black market for official transactions). In the language of international economics, the Naira has gotten weaker. That is, Nigerians need more of their scarce Naira to get U.S. dollars. The flip side is that the U.S. dollar has gotten stronger relative to the naira. That is, U.S. citizens can now get more Nairas for their dollar. This fact means that exports from Nigeria to the U.S. are cheaper than they were before the exchange rate changed. Now imagine where Nigeria’s export is just 20% of her trade balance; the devaluation becomes useless and will not benefit even Nigeria exporters; The People have lost their purchasing power and since imports are dollarized, we get no benefits as Nigerians will now require 25% more naira to buy any goods imported.

Come to think of it, a policy of deliberately weakening a country’s currency - devaluation - greatly abuses the logic in international trade that is promoted by the IMF, World Bank and the WTO (Bad Samaritans). This is all to give trade advantage to export advantage countries to the detriment of developing countries. For starters, the idea that a country can boost exports through devaluation is utter folly because it leaves out the importers. You promote devaluation to boost export without recourse to what will be the implication for the imports. All Nigerian trade partners, for example, could not possibly boost their exports at the same time, through devaluation or any other policy, because there would be nobody left to import all those goods. In this sense, the notion of boosting exports through devaluation is nothing more than the wrong-headed notion that exports are good, but imports are bad. This has always been the problem of Neo-Liberalism, where the same economic solution has been proffered for all developing countries since 1970 and it has led to the high income inequality; depression, recession, meltdowns, bailouts, slowdowns etc….It is not working, but they don’t care. It is working for the Bad Samaritan because it is another form of Colonialism. This time through economic slavery (Neo-Colonialism).

Another problem with the devaluation idea is that it ignores the possibility of retaliation. If countries buy into the devaluation logic, then they have no choice but to try to offset the moves of trading partners that devalue. If Nigeria devalues 10 percent against the U.S., wouldn’t the U.S. simply devalue by 10 percent in return? Otherwise, based on this devaluation policy, the U.S. would suffer. This sort of tit-for-tat devaluation would be counterproductive, to say the least. There are also some practical problems. First, countries like Nigeria are struggling to protect their External Foreign reserves and are therefore rightly involved with fixed exchange rates and can make the official rate whatever they want it to be, but have actually devalued to a point where it is more than enough for the benefit of her people. Countries such as Germany and the U.S., on the other hand, can’t simply switch to a new exchange rate because their currencies’ exchange rate is not fixed. For countries with these floating, rather than fixed, exchange rates, the next best option is to intervene in currency markets and/or to “talk” their currencies down. The U.S. Treasury, for instance, might try to sell U.S. dollars and buy British pounds in an effort to devalue the dollar against the pound. They may also then publicly praise the weaker dollar.

Aside from adding to international diplomacy difficulties (the IMF charter prohibits manipulating exchange rates to gain an advantage over other members, a deceptive and has not been enforced when the developed countries are found wanting), it’s at least questionable whether one country could sustain such an intervention to have a meaningful impact on a global market. Regardless, the entire premise is built upon making some people worse off at the expense of others. Foreign goods will cost more, so people’s standard of living will decline. Under devaluation, people quickly realize that they have to purchase items sooner rather than later to avoid paying higher prices. Thus, a sort of inflationary spiral frequently takes hold - devaluation leads to high inflation, high inflation causes a country’s exports to become less competitive on world markets, the country further devalues to make exports more competitive, and so on.

Remember when China who controls the renminbi or the yuan suggested that devaluation policies simply cannot overtake global market forces. The dollar - Chinese yuan exchange rate was virtually unchanged from 1995 to 2005, but China’s exports to the U.S. increased six-fold during this period. The value of currencies frequently changes when compared to other currencies, and those changes typically make some goods more or less attractive than others. But there’s no reason to think policymakers can exploit these facts to consistently improve their economies. In fact, there’s good evidence that devaluation policies tend to turn out badly. A much better option would be for governments to encourage export through infant industry protection, Manufacturing Subsidies and effective regulatory oversight that gives investors’ confidence about the economic trajectory of the country and in the process enhance the ability of local industries to compete with multinational corporations locally and compete internationally. Let us ask and answer three basic  questions and myth of devaluation;

Does Devaluing Currency Really Help Exporters?: Of course not, these actions are based on another popular misconception promulgated by economists: that a depreciating currency will allow exporters to reduce their prices overseas, helping them capture market share, thus boosting profits with positive ramifications for the domestic economy. The mistake in this logic is that it looks at the direct effects while totally ignoring other direct and indirect effects.

A simple example will make this clear. Suppose the exchange rate is one dollar for one Naira. The Nigerian exporter is selling his product for $100 in the US which he converts into 100 Nairas to cover his production cost of 80 Naira. Now suppose the Naira depreciates so that it takes 1.5 Nairas to get 1 dollar. The exporter can now lower his price to $66.66 since this will bring in the same number of Nairas as before the depreciation. He has gained a competitive advantage over his foreign rivals, with benefits to the domestic economy.

The first problem with this story is that with new financial instruments such as swaps and financial futures, many exporters can hedge their foreign exchange risk long term, and may have already committed themselves to the rate they swap dollars for Nairas.

The second problem with this story is that many exporters today import many of their inputs. A Ford Assembly Plant in Onitsha has parts coming from all over the world. Its engines may come from the UK. The leather seats may come from China and the steel may come from Brazil. If the depreciation causes input prices to rise from 80 Nairas to 120 Nairas, the exporter will be unable to lower his dollar prices, and, therefore will not gain in competitiveness. Of course, not all costs are imported inputs. 

Workers Don’t Benefit from Devaluation: If domestic cost, mostly labor, does not adjust to the higher import prices resulting from the depreciation, exporters will gain, but this gain comes from reducing the real incomes of domestic workers. If these workers ultimately negotiate an increase in nominal wages to bring their real wages back up to before the depreciation, the gain to exporters will disappear. The depreciation has created only a temporary gain. Few journalists seem to understand that a policy to reduce the foreign exchange value of a currency is, in reality, a policy to transfer wealth from workers — the middle class and the poor — to the wealthier owners of export industries. It is another example of the central bank acting as a reverse Robin Hood, taking from the have-nots to give to the haves.

Furthermore, there are many other indirect effects that make depreciating your currency a very bad policy objective. It can be further explained that standard balance-of-payment accounting cannot be used when the unit of account is being distorted. Even if exporters are more profitable, this is not something to cheer if a higher nominal profit means lower real profit. Of course, other economic actors are also hurt by a beggar-thy-neighbor policy. Consumers will bear the brunt of higher prices on foreign products. Domestic firms who import their inputs and sell on the domestic market will also likely be hurt.

Distorting Prices Hurts an Economy:  A depreciating currency reflects a country’s central bank printing money faster than its neighbours. Yet, this printing hurts all firms, including exporters. Printing money alters absolute and relative prices. It interferes with the critical signals that prices send across time about what and how society wants goods and services to be produced. What Nigeria needs is not a weaker naira, but significant structural reform. Nigeria should learn from Latvia’s experience with reform. In 2009–2010, Latvia cut government spending from 44 percent of GDP to 36 percent; Nigeria’s debt to GDP is even below 15% and the need for panic is uncalled for. Latvia fired 30 percent of the civil servants (Not Recommended in Nigeria), closed half the state agencies (PMB has already reduced the MDA’s signicantly), and reduced the average public salary by 26 percent in one year (Nigerian must reduce the average Leadership Salaries and budget in the Executive and Legislative arms of government by 50%). Government ministers took personal wage cuts of 35 percent (50% is Recommended for Nigeria). The Latvian economy initially dropped 24 percent, but rebounded sharply with yearly real growth of nearly 5 percent over the last three years. Yet, Latvia did this without using currency as a weapon since it kept its former currency, the lats, fixed against the euro.