Nowadays most of World countries face a nominal exchange rate depreciation, therefore it is time to invest and be more productive in order to reach economies of scale as global economy demand. However, there are developing countries that try to depreciate nominal exchange rate to be competitive, it means they have a lazy industrial sector (mainly in those sectors which export products) or they want to take advantage of government lack of information. Colombia is in the group that want to depreciate nominal exchange rate by force (through expansive monetary policy), this country wants a nominal exchange rate of Col$1,950 per dollar when market says it is Col1,778 per dollar. This depreciation by force can bring higher inflation rate and again real appreciation through higher prices. To be competitive in this global economy, industrial sector needs to work hard in improving their technologies to reach economies of scale, now it is time to hire foreign and local advices and buy the latest generation of capital.
Author: Humberto Bernal,
Economist,
e-mail: zhumber@gmail.com
The nominal exchange rate (US$ in terms of local currencies) around the world showed an average grow rate of -2.6% between 2012 and 2013, it means an appreciation, of course there were countries which faced depreciation, they are about 15% of 52 countries such as Argentina which faced a depreciation of 15% and India with a depreciation of 2.9%. The first of these two countries can get huge economic cost in the long run due to this policy, for India case, this policy can bring economic growth in the long run, the issue is the first one does not face economies of scale in most of her products but India does.
Figure 1. Nominal and real exchange rates Index in Colombia 1980-2011
(adjusted by maximum value)
Source: World Bank.
Now, the issue is how countries are dealing this appreciation. There are countries which let free floating the nominal exchange rate and they do not work in improving their productivity through better technologies that let reaching lower prices, in this group are Colombia and Venezuela. In Colombia case the appreciation of nominal and real exchange rate e=(P/EP*) are showed in figure 1, the main fact is Colombia prices are not competitive due to as nominal exchange rate (E) goes down the local index price (P) goes up, moreover index prices from foreign goods are competitive (P*), it means foreign prices show a negative growth rate to be competitive, for instance Peru shows a stable real exchange rate (it means the nominal exchange rate appreciation is neutralized with lower local prices), other country which shows same situation is Chile as figure 2 shows, the nominal exchange rate (blue line) showed an appreciation but the real exchange rate is stable, it means economies of scale. Both Peru and Chile are competitive at international trade market, therefore their exports and GDP shows strong growth.
Figure 2. Nominal and real exchange rates Index in Chile 1980-2011
(adjusted by maximum value)
(adjusted by maximum value)
Source: World Bank.
Tray to be competitive through a depreciate local currency can be a big mistake, figure 3 shows the Big Mac index, most of developing countries face a real exchange rate depreciation (negative numbers), therefore any attempt to depreciate will not be successful due to their currency are not as strong as US dollar as it is pointed below.
*Highlighted overvalued.
Source: The Economist and Wolfram.
Figure 3. Big Mac Index 2013 (January)*
Source: The Economist and Wolfram.
Any monetary intervention is useless: Colombia case of Col$1.950 per dollar.
As was mentioned before, most of countries face a nominal exchange rate appreciation, therefore if a country tries to make a monetary policy to get a depreciation, it will be useless in the long run and expensive in terms of high inflation unless this country would has strong currency and productivity as the United Staes does. Colombia government wants to depreciate her currency from Col$1,776 per dollar to Col$1,950 per dollar and the result can be disappointed in terms of economic growth. Here is the scenario that can be if government tries to depreciate local currency by force: if Colombia government would buy huge amount of dollars in the local market, then nominal exchange rate will face a depreciation from Col$1,776 per dollar to Col$1,950 per dollar as government wants but foreigners and locals speculators can make an arbitrage strategy (short run capital flows), for instance speculators go to Peru or Chile (web transactions) and they spend Col$100,000 buying local currencies, for instance New Peruvian Sol (Per$); speculator can buy Per$141.80 with Col$100,000, then they would spent this peruvian money in dollars; US$53.66 with Per$141.80; and finally they sell these dollars in Colombia in Col$1,950 per dollar that means Col$104,637, it means a profit of Col$4,637 if speculators spent Col$100,000 at the beginning of transaction, therefore if speculators are a set of big financial enterprises, they will get huge profits and colombian government will get losses due to government has to buy dollars at higher prices Col$1,950 per dollar to keep Col$ depreciated.
This transaction can be done in less than a day (seconds in the best of scenarios). Moreover this government monetary strategy at the end means more local money supply that bring high inflation rates and a real exchange rate appreciation again due to high local prices. The OECD ( The Organization for Economic Co-operation and Development) has pointed the negative to tray to depreciate local currencies at this moment, from my point of view this this assessment is logic due to developing countries have to improve their technology and productivity to be competitive in the global market through lower prices and product differentiation, nowadays there is a monopolistic competition in the global market and economies of scale make the difference instead to be competitive through nominal exchange rate depreciation.
Note: Nominal exchange rates were taken from official financial webpages.
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