Is there such a thing as the “right” exchange rate?

26th November 2013 by Shaun Richards

One of the strongest forces in economics is often either ignored or treated as something that cannot be controlled. The Bank of England has regularly chanted Shaggy’s hit “It wasn’t me” when confronted with the consequences of the 2007/08 over 20% fall in the value of the pound sterling on the foreign exchanges. However as central banks around the world run out of policy options (you do not have to believe me on this subject simply watch the number of denials that this has happened as confirmation) we are likely to see ever more join the ranks of those attempting to lower or devalue their exchange rate. It was only on the 11th of this month that I discussed the way that the Czech National Bank had started on its own adventure to lower the value of the Koruna.

The Driving Forces

This can be summed up with two factors. Firstly economic growth is disappointing in many areas highlighted by the way that the OECD reduced its economic growth forecasts by “about half a percentage point” only last week. This had a consequence for another area of their forecasting which if it turns out to be true will put further pressure on central banks.

The jobless rate in OECD countries is projected to fall by only half a percentage point, to 7.4%, by the end of 2015, a slower decline than had been expected.

Secondly more and more countries are finding themselves suffering from disinflationary pressure and those with high debt burdens find this uncomfortable. This is something I analysed only yesterday for the Euro area which is currently facing this issue.

The Catch

As currencies are valued in terms of other currencies for each one that goes down another must be going up. There is no avoiding this in what is a zero sum game unless of course the answer to David Bowie’s question “Is there life on Mars?” is not only yes but that they have something to trade. This is why Brazilian Finance Minister Guido Mantega talked of “currency wars” back in 2010 as the Real found itself rising and rising against the US Dollar. That phase ended but we have seen new issues rise in 2013.


One possible exception to the zero sum game is that a currency can move against precious metals such as gold. As it rallied in the early phases of the credit crunch pretty much every currency did fall against it. But 2013 has seen paper currencies appreciate against gold as it has fallen from US $1675 to US $1250 per troy ounce. Even the currencies such as the Japanese Yen and the Indian Rupee which have been amongst the weakest in 2013 have appreciated against gold.

For those interested in the old style of mercantilism the pattern for Silver is similar to that of Gold in 2013. So we have seen paper currencies appreciate against precious metals in 2013 which has me wondering what economic effect this may have caused.

Those applying the currency war strategy


In essence the main arrow of Abenomics is to depreciate the Japanese Yen and by that route reinvigorate Japanese industry via the route of price competition. Somewhat sneakily the consequent inflation from this is also a policy aim which will not be welcomed by Japanese consumers and workers. Having started the year at just below 87 Yen to the US Dollar it has fallen to 101 Yen to the US Dollar. It now takes 137 Yen to buy one Euro as opposed to the 114 at the start of 2013 and for the pound the current number is 164 Yen versus the 141 of the new year.

So Japan receives a competitive advantage and boost from a weaker currency. However on the other side of the coin the Euro area gets another push towards disinflation as everything priced in Yen has got a lot cheaper in 2012.

However some care is needed in the treatment of Japan as a currency manipulator as the Yen was driven higher by the carry trade and has so far only returned to the levels of 2009. So if you think of it as jumping into Dr.Who’s TARDIS it has not got far. Although a cheerier thought is that it is back close to the levels where the Euro began in 1999.

We are left with the thought that there are two factors at play here. Firstly there is the level and secondly there is the rate of change of it. Fast moves can lead to economic dislocation even if they are correcting a previous imbalance.


The Rupee has had a ropey 2013 even though the dark days of September when it nearly touched 69 versus the US Dollar have been replaced by a calmer 62.5. Even so this is a nearly 15% drop on where it started the year. This adds to previous falls which suggests that India is something of a serial offender in this area.

But there is a nuance in this in that much of this was outside its control. Whilst the actions of the Reserve Bank of India in February were questionable and risky as I discussed at the time in the article linked too below the currency was also affected by the backwash of the US to taper or not too taper debacle.

It is sobering to consider a nation and economy the size of India’s being a bobbing cork on the ocean of US monetary policy especially as it was a combination of mistakes which caused it. The chapter in economics textbooks on “small open economies” needs some revision to say the least.

The Commodity Currencies

These have been falling in 2013 as commodities  prices have dipped. Both the Aussie and Canadian Dollars have been falling as the consequences of being a commodity based asset with a population attached are being digested. If we look at the Aussie Dollar versus the pound it now takes 1.77 to buy a pound as opposed to 1.56 at the start of the year. The problem however for Australia and Canada is that this is outside their control causing a situation which Canadians might well regard as loonie.

These matters have consequences which often come under the category of be careful what you wish for. Those of the Barmy Army who found that the price of following the UK cricket team took a dip may after the result of the first test be wishing that it had not!

Switzerland and the Czech Republic

If we consider the problems of the Euro it is revealing that both Switzerland and the Czech Republic have capped their currencies against it. In something of a theme Switzerland has found that a solution to one problem (a surging Swiss Franc) has turned its national bank into a hedge fund with enormous foreign exchange reserves to invest. It would appear that the Czech National Bank is on the same road albeit on a more minor scale.

The Czech National Bank bought foreign exchange worth about CZK 200 billion in its foreign exchange interventions in the period up to 20 November. According to the ten-day balance sheet, the CNB’s total assets increased to CZK 1,077 billion as of 20 November 2013.

However there is something disturbing in this next bit of their statement.

 an effort to avoid the risk of harmful deflation and to maintain price stability.

What they are actually doing is exporting such problems to others. As they are specifying the policy against the Euro then that is where the main effect will be felt.

Who is appreciating then?

There must be currencies rising as others fall. We are losing many of the ones which were rising strongly as either circumstances have changed or they have acted to stop it. Some currencies have risen as the Euro is up 4% in 2013 and the Chinese Yuan is up by 2.4% whilst the pound has risen in recent months however care is needed as it has merely returned to where it began the year. The US Dollar has not moved much either at -1%.

So it seems that a lot of currencies that are not on the main list have risen in 2013.


The situation is fraught with danger right now as any further economic disappointments will push more central banks towards the currency depreciation option. This will happen at a time that it is not so easy to achieve as monetary policy is already loose in so many areas. Accordingly the danger of repeating the mistakes of the competitive devaluations of the 1920s and 30s is rising. Sadly if that happens we be further on our way to repeating pretty much the full set of mistakes from that era.

Underlying all this is a very difficult question which seems simple. What is the right exchange rate? Right now Japanese consumers and workers would be likely to give a very different answer to its government. But all readers of this blog can play that game, whatever country you are in, what do you think is the “right” exchange rate for it? I will be fascinated to see the replies….

There is a country that may be about to engage in this game for real as Scotland considers not only independence but what currency it might have. Let me drop a hint as so much depends on whether it discovers any more oil or gas as at that point attaching to a larger currency gets much more attractive.


20 thoughts on “Is there such a thing as the “right” exchange rate?”

  1. Stephen Brown says:

    Koruna, not kronor….

    1. Anonymous says:

      Hi Stephen

      Thanks for pointing that out. I had spotted it myself but the first draft was wrong so apologies.

  2. forbin says:

    Hello Shaun

    not much to say about exchange rates and wars – they always seem to be short term and short sighted affairs

    in the long run its your balance of payments – and Scotland as I believe we know joined the union because they were broke ( amongst other things)

    As for more oil and gas , well there is some but lets not forget that we’re never going to see again 3 million boe again

    but whats left , if it goes to Scotland and not the orkneys , may well prove to be a help – short term one that is because they’re never going to have a fund like Norway….


    1. Anonymous says:

      Hi Forbin

      Yes if the independence game really catches fire then the Orkneys could go for independence from Scotland or join England or even Norway!

      The proposed currency arrangement looks odd to me. If you want independence why would you keep the English pound? There are grounds for that not to be in England’s interests…

  3. Drf says:

    Hi Shaun,

    “Accordingly the danger of repeating the mistakes of the competitive devaluations of the 1920s and 30s is rising.” I would suggest the reality is not that it is rising, but that this error has already been repeated and is continuing apace, probably at an even greater overall rate than in the 1920s and 30s?

    It also seems that to be able to do this and to avoid natural market price discovery mechanisms to take place with currencies against core precious metals such as silver and gold, the markets for the latter are and have been recently continuously manilpulated. There are two reasons I believe for this: firstly such natural price moves particularly in gold and silver would have exposed the real drop in the purchasing power of debased currencies; secondly the UK and US central banks have sold off (as well as leased) a significant amount of the gold which they were supposed to have in their vaults (some of which actually was held on behalf of other sovereign states, such as Germany). There is some evidence (notwithstanding any questions of moral uprightness) to suggest that the main reason that DSK was set up with various allegations of sexual misconduct was that he had discovered that the gold was missing from US and UK central banks and was threatening to expose it; he thus had to be discredited and removed. So the market prices of gold and silver have been manipulated downwards for these (and other reasons such as exposure of certain banks to some futures). As some owners of gold held by other central banks have demanded its return those central banks now short of the gold they were originally holding need to purchase replacement bullion at the present market price; they thus need to manipulate the market price downwards.

    This has disguised the true debasement of currencies – for a time – but in the future eventually the reality will be exposed, because there is a limit as to how long they can continue to manipulate the market gold and silver prices. As Warren Buffet has neatly expressed it, when the tide goes out you are able to see those who were not wearing any bathing garments!

    1. Anonymous says:

      Hi Drf

      I have also wondered if the advent and rise of Bitcoin has diverted some money from precious metals. Certainly the amount of QE has not reduced with both the Federal Reserve and particularly the Bank of Japan running at full speed.

      If gold is being manipulated downwards the risk for the manipulators is that they running into more and more buyers especially those that want the product itself….

  4. Anonymous says:

    Hi Shaun
    You are right that exchange rates are rarely discussed. To my mind the problem right now is the Euro which is too high for many of the nations within it. But as you say for it to fall someone else has to rise. It is quite a problem as who wants a strong currency?

    1. Anonymous says:

      Hi Josephine

      Very few right now is the answer to that.

  5. Eric says:

    Hi Shaun,
    I’m in New Zealand right now. The country doesn’t seem to be economically disadvantaged by a strong NZ dollar.
    The PM (an ex money market trader, I believe) has said he doesn’t believe in exchange rate intervention- “never have, never will”; yet the media has reported that the Central Bank has intervened on occasions.

    1. Anonymous says:

      Hi Eric

      I like the contrast between political rhetoric and reality! That is true so often is it not?

      The Reserve Bank of New Zealand is worried by the currency and its possible impact.

      “However, the Reserve Bank believes that, from a long-term perspective, the exchange rate is overvalued. The high exchange rate is contributing to economic imbalances and the Reserve Bank would like to see it lower in order to promote more sustainable economic growth.”

      It may be a carry trade impact to some extent as these days even a 2.5% interest-rate may attract some hot money.

      Is there any news on house prices over there? I gather there have been some rises….

      1. Eric says:

        Hi Shaun,

        There seems to be no holding the Auckland property market back. It could be the driver for an upward move in interest rates which currently sit at historic lows. New restrictive rules for mortgages and deposits were introduced recently in an attempt to cool things down. Elsewhere property has been fairly dull for 5 years. The costs and benefits of rebuilding Christchurch appear on both sides of the ‘balance sheet’.

        And Auckland is enjoying its hottest November on record.

        1. Anonymous says:

          Auckland has demand for both rental and purchase, that outstrips the supply. Workers need to live where the jobs are … Add in favorable interest rebates for BTL and a share market that small investors are skeptical of – you have the same British housing mess.

          1. Eric says:

            Yep – most kiwis, not just Aucklanders, have a high regard for property as an investment. Many got burned in the 80s stock market crash and although banks here have done pretty well throughout the credit crunch some people have lost all their money in the demise of local “finance houses” – around 24 have gone bust over the last 5 years.

            Right now the government hopes to tempt small investors again with a fresh round of asset sales – Air New Zealand and power generation companies.

            Fortunately, NZ has a resource economy and seems to have no trouble exporting dairy products with a high $. The UK is no longer the major export market. Most exports go to Australia and China.

          2. Anonymous says:

            The Commons agricultural policy blocks trade to Britain, forcing Brits to pay over the odds to French farmers.

          3. Eric says:

            And I understand that the NZ dairy industry is entirely un-subsidised….

            It’s not hard to figure out what works and what doesn’t.

          4. Anonymous says:

            I really wonder, ExpatInBG. A salient difference would be that the BoE had, and has, a dysfunctional inflation indicator, the UK CPI, that excludes housing prices, whereas the Reserve Bank of New Zealand targets a CPI with a net acquisitions approach to owner-occupied housing. It was the first central bank to adopt such an inflation measure as its target indicator. Not that this may necessarily save them from a housing bubble, but it seems unlikely it would be such a big one, or have such bad consequences.

  6. Noo 2 Economics says:

    Late in the day I know but the answer is simple – whatever the market determines – that is excluding interventions from the authorities, but then again, perhaps w e have entered a new “normal” where Central Banks are now part of the market?

  7. Anonymous says:

    Shaun, most of the central banks you mentioned are now inflation targeters. If you asked them what was the right exchange rate they would say that there was no right exchange rate, but that they would react to exchange rate changes that threatened achieving their inflation rate targets. Of course, the Bank of England abjectly failed in this regard with the 2007-08 devaluation which helped push the inflation rate way above the 3% upper bound.

    There are a few European central banks that follow an explicit exchange rate policy. If you asked someone from the Central Bank of Bosnia and Herzegovina what was the right exchange rate for their country’s convertible marka (KM) against the euro, he would tell you it was 1 KM=051129 euros; this is the fixed exchange rate that they establish. For such a small economy that sees its future in the EU and the euro area, it is not an unreasonable monetary policy to follow. The Macedonian Central Bank, also follows a monetary policy of targeting the euro exchange rate. The different regions of Yugoslavia started moving away from a single currency, the Yugoslav dinar, in June 1991, with the Croatian and Slovenian declarations of independence, but it seems they will likely all have a single currency again, the euro. Only Slovenia is a part of the euro area but Croatia is in the EU and declared its intentions of adopting the euro as well, Kosovo and Montenegro have simply adopted the euro, Bosnia and Herzegovina and Macedonia I just discussed. Even Serbia, while its central bank has a BoE-inspired inflation targeting regime, is undergoing a slow-motion euroisation of its economy. Very few transactions that involve big money in Serbia are conducted in dinars and not in euros.

  8. Everything keeps just need to stay alert when the “right” exchange rate comes. Euro, pounds and bahrain really do have a high exchange rate..and keeps on improving from time to time.

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