Why are so many currencies suddenly appreciating all over the world?
By Scott Sumner
Many readers might be confused by the title of this post. Haven’t we been reading about a currency war? Aren’t competitive devaluations occurring one after another, all over the world?
The answer is no, for a very simple reason—it’s impossible. All exchange rates are two sided, which means the net amount of devaluation and revaluation on any given day, week, month or year is exactly equal. There can never be net overall devaluation or revaluation occurring in the world’s forex markets.
Suppose there are 100 currencies. In that case there are approximately 100 squared, or 10,000 bilateral exchange rates. But if we ignore the 100 that are exchange rates with themselves, we have 9900 actual bilateral exchange rates. And each change is a depreciation in one direction and an appreciation in the other. If the yuan price of euros rises, then the euro price of yuan falls. So I can say with confidence that every single day 4950 currencies will appreciate in the bilateral exchange rate, and 4950 would depreciate (assuming each exchange rate changes by at least a tiny bit–some might not change at all.)
However there are other ways to define the value of a currency. For instance, you could look at its purchasing power over commodities. By that definition most of the world’s key currencies have been appreciating in recent month, including the Chinese yuan. That’s just another way of saying that commodity prices have been plunging. The title of this post reflects the fact that it’s meaningless to make generalizations about which way exchange rates are moving in the world as a whole, and hence any generalizations about the world’s currencies must involve some other measure like commodities, to be meaningful at all.
The “never reason from a price change” maxim tells us that lower commodity prices could reflect increased supply or reduced demand. My hunch is that its a bit of both, but the very recent plunge in so many commodities is more likely demand driven, as supply side improvements like fracking rarely impact lots of commodity markets at the same time.
China is by far the biggest consumer of many key commodities, and this suggests the Chinese economy is slowing, probably due to tight money policies, although also partly due to things like the crackdown on corruption, which makes local officials more cautious about green-lighting new projects.
China needs easier money, as does Japan, the eurozone, the US, Sweden, and lots of other places. I guess I’m beginning to sound like a broken record. When was the last time in world history that naysayers who sounded like broken records were, in retrospect, correct? The Great Inflation. And the time before that? The Great Depression. So every few decades the world goes into a prolonged period where its central banks get it wrong in the same direction, for many years in a row. We are in one of those periods now.