Thursday, February 9, 2012

The Fallacy of Prosperity Through a Devalued Currency (again)

I have come to conclude that one of the main reasons that devaluing the currency is advocated is to boost reported earnings for multi-nationals in their home country, therefore increasing the stock price and therefor increasing the wealth of the management. Of course, the politicians will latch onto any story that allows them to spend without discipline.

Bear with me....

It is clear that in order to consume one must produce. Inherently, it is also true that in order to produce one must consume. As no company (or nation) is self-supporting for all materials in production, the materials must be acquired before the finished goods can be sold. With a depreciating currency, once the existing stock of materials is consumed, the new stock of materials must be purchased - at a higher price. Even for commodities produced locally, prices are set for most commodities internationally – again, currency devaluation will increase the cost of these inputs.

For small businesses that sell locally, currency devaluation is devastating, bringing on hardship and potentially bankruptcy. Raw materials must be purchased at a higher price, yet passing along the increase to consumers is not assured.

But for the larger multi-nationals, this is not such an issue. Most large multi-nationals are not classified as such merely because they sell internationally. Most of them also produce internationally. In other words, the devaluation of the local (home) currency means little to these firms when they are producing and selling in dozens of different countries around the world – with production and sales (along with the capital structure) reasonably aligned to minimize the impacts of currency fluctuations.

In the meantime, back to reported earnings. The large multi-nationals, reasonably protected from the negative ramifications to their cost structure of the devaluated home currency due to the international diversification of their production, now gain the benefit of reporting higher revenue and earnings in the home market due to the devaluation of the home currency. Higher earning, higher share price, bigger bonuses. Like magic.

I conclude that the devalued currency – in addition to destroying the wealth of those who have saved in such units – ruins local manufacturers to the benefit of multi-nationals, while at the same time further benefitting multi-nationals via falsely inflated reported revenue and earnings.

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