The Shrinking Denominator

We are living in an era of cheap currencies. Gone are the days when devaluation was taken up to balance the deficit of payments, to speed up manufacturing sector, create employment opportunities thereby providing social and economic growth. Putting it in a better way, depreciating currency is not a reliable measure to improve economy, unless and until Government executes proper economic planning so that the amount of devaluation stabilizes the external value of money.

the burning US dollar US Economic Recession and its effect throughout the rest of the world

But the present situation deliberately deviates from the execution of the fact that devaluation of currency is unreliable. In fact, it seems as if it has become a practice and not remained a necessity anymore. As more and more countries are bleeding in debt, the easiest way the Governments find to cope is cheapen their currencies and create more money. Don’t they realize that creating more and more money dilutes its buying power? If they do realize this fact, then why are countries indulged in this global currency war? Have they ignored the fact that there are many dangers associated if value of money is reduced too quickly? I don’t think there is any dearth of world class economists who may not be acquainted with the fact that rapidly depreciating currency leads to lack of investor confidence and termination of foreign investments in the country which would ultimately make it impossible to finance the current trade deficit! In spite of all this, this practice continues. Why?? The only argument made by many is, US and other economies can recover by improving upon exports, and a devalued currency would help doing that. More and more countries are realizing the trade advantage from weaker currencies and have plunged in this currency war. They are reluctant to appreciate their currencies because of the fear that doing so will not only lead to loss of their permanent share in market but also their competitiveness in market share. China had been gaining unfair trade advantage through its weak currency, but has been pressurized by European Union countries to raise its currency.

Wrong valuation of US dollar economic recession of US and its effect on the rest of the world

The US debt is so large that simple measures like increasing tax, reducing deficit can’t resolve the situation. Also effective measures like reducing entitlements and withdrawing overseas troops can’t be implemented if the political situation of US is considered. As a result, US is pumping huge reserves of liquid money in its commercial banks.US banks today hold $1.6 trillion excess reserved money, which was $1 trillion a year ago. Whereas, only $77 billion is the amount required to reserve. Almost an unimaginable situation for any developing country to hold such huge amount of liquid money. The effect has been more disastrous. With huge debt and economy paralyzing gradually, unemployment rate has risen. Consequently, the biggest fear is that, if the unemployment rate continues to rise, investors will lose confidence, businesses will be unwilling to take risks, thereby elevating the tendency to hold assets in liquid forms, etc. So, if US economy continues to perform badly in the second half of the year, US Government will be forced to print money and devalue its currency. Well, there are signs of recovery from the debt crisis, but the impact on the globe is going to last long.

The long lasting effect of which I am talking about is while the countries are involved in this rat race of cheapening currencies to gain trade advantage, aren’t they focusing on the flipside of the situation? Aren’t they aware of the fact that steep decline of currency gradually leads to inflation? US will come out of the crisis some day or the other as it has that much of capability to do so but, if this continues, will other countries be able to overcome the vicious trap of inflation? As the currency deteriorates, import of goods and services become more expensive, hence causing inflation. Presently, prices of gold, oil, wheat, sugar, soybeans are touching new heights. How is the common man supposed to survive? Why is he paying the price of this currency war without any fault of his? A commodity price is taken as ratio of demand in the numerator and the value of currency in the denominator. While the population is proportionately increasing day by day, causing the demand to rise manifold, keeping the denominator high, the value of dollar and euro is drastically decreasing. The denominator is shrinking!!! As a result there has been a huge gap in meeting the demands of the people. World economies should gear up, realize that depreciating currency is not the only way to grow economy. Economic growth is incomplete unless and until the demand of the crowd is optimally met.

Guest article by Rajlakshmi Mitra – IBS Hyderabad

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