How do you know if a currency is overvalued or undervalued? Well, there are currently many measures that contribute to determining the fair value of a currency. One common measure is evaluating purchasing-power parity (PPP) and another is determining whether or not a country’s trade deficit or surplus is representative of the country’s fundamental economic attributes. Although these factors can together accurately determine a currency’s fair value, a universal method is still lacking.
Because of the euro’s widespread use geographically, it is subject to a lot of debate. Some argue that without Germany’s sturdy economy, the value of the euro would be much weaker. Amer Bisat, a managing partner at Traxis Partners and part-time professor at Columbia University, argues, “What is fair for one part of the zone is very unfair for other parts of the zone.” Having a single currency in an economic region makes traveling easier, facilitates international trade, and increases price transparency but makes it more difficult for an individual country to control its monetary policy and exchange rate. Problems like these were contributing factors to the near collapse of the euro.
One argument that advocates the creation of a universal measure for currency is that international problems are caused when a country intentionally devalues its currency. Intuition would lead us to assume that a strong currency would be preferred, but some countries disagree. These countries argue that an undervalued currency gives their exports a competitive advantage in the international marketplace, but if the currency is too underpriced, rampant inflation can result. Additionally, countries that import from countries with weak currencies are negatively affected because more expensive domestic products become less attractive.
In most cases, countries have the ability and right to manipulate their currencies, but a universal method for valuing currency would lead to a fairer international trade system. Then, competitive pricing would be driven solely by manufacturing, shipping and labor costs and not by undervalued currencies as well. The questions are what will this method be, who will implement it and is it really even possible? What do you think? Feel free to leave a comment below.