ANDBANK RESEARCH Global Economics & Markets MACRO & MARKETS
Alex Fusté Chief Economist alex.fuste@andbank.com +376 881 248
Working paper - 86 About Mr. Draghi’s fallacy & the fate of the Euro February 2015
Corporate Review
One of the greatest fallacies in economics is to believe that devaluations lead to an improvement in exports and therefore in the national economic conditions. The reality is quite different. The devaluation processes are in most cases neutral from a current account perspective. What is more, devaluations often signal a worsening current account for the nations adopting them. That is because devaluations are not really a cause, but a consequence.
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The idea of the “competitive” devaluation is a fallacy in the current global context.
GBP EXCHANGE RATE - BROAD 110
110
105
105
For example …
100
100
95
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UK allowed sterling to depreciate a 30% against its major trading partners since late 2007 …
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32% depreciation in just one year
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75
70 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11
70
GBP Exchange Rate vs basket (EUR, USD, AUD, CAD, HKD, SGD, CHF, JPY) Source: Andbank
©FactSet Research Systems
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… and the recent devaluation, seen in perspective … … has been the quickest and vigorous devaluation in modern British history. GBP EXCHANGE RATE - BROAD (ex-eur) - Index100 Base date 2000 300
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250
-30% in 1.5 years
200
200 -17%
150
-14%
-21%
-32%
150
100
100
50
50
'62 '65 '68 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 GBP Exchange Rate vs Basket (USD, AUD, CAD, HKD, SGD, CHF, JPY) Source: Andbank
©FactSet Research Systems
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Yes. When seeing some improvement in the external sector coinciding with devaluations, people’s perception is that “such devaluations work well”. 1
UK - NET EXPORTS OF GOODS & SERVICES, NOMINAL - % GDP
0
0 Improvement in UK trade balance, coincided with the 08’s 30% devaluation of sterling.
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1
Improvement in UK trade balance, coincided with the 92’s 15% devaluation of sterling.
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'92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11
-4
(MOV 1Y) Net Exports G&S as a % of GDP
Source: Andbank, UK Office for Nation Statistics
©FactSet Research Systems
Then, why do we cast doubt on the effectiveness of devaluations?
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1st: Seen in perspective, you may also realize that devaluations, not always translates into improvements in external sector… 4
UK - NET E X PO RT S O F G OO D S & SER V I CES, NOMI NA L - % GD P
Net exports declined
3 2
… and this, at least, suggests some doubts about the effectiveness of devaluations.
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1
0
0
-1
-1
-2
-2
Net -3 exports -4 declined -5
300
-3 -4
'65 '68 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13
GBP EXCHANGE RATE - 1Y) BROAD (ex-eur) - ofIndex1 00 Base date 20 00 (MOV Net Exports G&S as a % GDP
300
Source: Andbank, UK Office for Nation Stat istics
©FactSet Research Syst ems
250
250
43% Devaluation
200 150 25% 100
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Devaluation
200 150 100
50 50 '65 '68 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13 GBP Excha nge Ra te vs Ba s ke t (USD, AUD, CAD, HKD, SGD, CHF, JPY) Source: Andbank
©FactSet Research Systems
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2nd: A substantial share of the positive adjustment in trade balance came from de “Demand Side”, and not as a consequence of devaluation. As the BoE stated: “Empirical estimates suggest that the impact of changes in demand on trade, is typically stronger than the effect of changes in prices”.
Indeed, Demand effect in the UK is three times more powerful than the exchange rate effect*
* Gavekal, April 16, 2012.
8 6 4 2 0 -2 -4 -6 -8 -10
DOMESTIC DEMAND UK VS COMPARABLES (% YoY)
UK domestic demand has underperformed its major trading partners since mid 2008
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UK (% 1YR)Italy
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(% 1YR) Austria (% 1YR)Germany
Source: Andbank, Eurostat, ISTAT, Polish CSO, German Fed. Stat
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(% 1YR) Eurozone (% 1YR)EU (25)
©FactSet Research Systems
Put simply, the recent gains seen in UK Trade Balance coincided with a 30% devaluation period, but was mostly explained by domestic factors (strong decline in demand) and not by devaluation. Strong decline in demand lead to a fall in imports and thus, to a significant improvement in trade balance.
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3rd: Despite the “theoretical advantage” of a huge devaluation, the UK external sector has not performed well relative to competitors.
From the start of 2008 (the inception of the “big devaluation”) … UK exports have not managed to outperform European countries. In fact, the UK ranks among the worst!!
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EXP ORT S OF G OO DS & SERVICES - UK Vs CO MP ARABL ES (Mi lli on EUR,Cha i ned 2 0 1 0 p ri ces , MA1 2 m , Ind ex 1 0 0 )
150 140 130 120 110
UK
100 90 80
'07
'08 Spain
Source: E urostat , Andbank
'09 Germany
'10
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'12
France
Swit zerland
'13 UK
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It aly
©FactSet Research Syst ems
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4th: CHF and GBP have travelled in opposite direction … 160 150 140 130 120 110 100 90 80 70
F X - CO MP ARAT IVE - G BP & CHF Vs EUR
'07
'08
'09
'10
'11
160
'12
'13
'14
150 140 130 120 110 100 90 80 70
(INDEX) FX Rat e - Spot Mid - Euro per British Pounds (INDEX) FX Rat e - Spot Mid - Euro per Swiss Franc
WM/Reuters, Andbank
… while GBP has lost a -15% of its value vs the EUR in the same period…
©Fact Set Research Systems
2.8
… which resulted in an incredible depreciation (-42%) of the Sterling against the Swiss Franc! …
The Swiss Franc has appreciated 35% vs EUR(in recent years) …
GBP - CHF EXCHANGE RATE (Price of one GBP)
2.8
2.6
2.6
2.4
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-42% depreciation of the GBP vs CHF
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(1/X ) FX Rate - Spot Mid - British Pounds per Swiss Franc Source: WM/Reuters, Andbank
©FactSet Research Sys tems
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4th: … however, despite this tremendous “advantage”, the UK exporters has failed to outperform Swiss exporters.
… and that gives an extraordinarily clear indication of the inherent limitations of devaluations.
120 116 112 108 104 100 96 92 88 84 80
UK EXPORTS / SWISS EXP ORTS (Rea l, Ind ex Bas e10 0 )
'07
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120 116 112 108 104 100 96 92 88 84 80
(MOV 1Y , INDEX) Exports of goods & services, Mil €, Real, SA - UK / Switzerland
Eurostat, Andbank
©FactSet Research Systems
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Conclusions: 1. Devaluations not always translates into improvements in external sector (as has been demonstrated). 2. A substantial share of the improvement in the trade balance most often comes from the “demand side”, not from the effects of devaluation. 3. The coincidence in time with a devaluation, causes this economic myopia. 4. It is an empirical evidence that in some countries, such as the UK, despite enjoying the theoretical “advantage” of a tremendous devaluation, the external sector has not performed well relative to competitors. 5. “Competitive” devaluations” work well only … With a high level of savings (that help offset the non-progressive tax effects of devaluations) If there is “similar” cost structure with competitors (no longer the case). If there is a relatively low and stable level of energy prices and a low intensity in the use of energy (no longer the case of the Eurozone that supposedly could pursue devaluations).
6. Whoever is in charge of the monetary (and thus, the exchange rate) policy in the Eurozone, he is pursuing a blatant manipulation of the exchange rate in order to seek competitive advantages for the external sector. He will fail. 7. Even worse. It will cause an outflow of capital (projects now unviable with the new perspective for the exchange rate). This will cause further declines in the value of the currency (devaluations are a consequence, not a cause) while it will reduce the potential GDP.
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