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It is common to hear explanation like "Yuan has lost value, this helps Chinese exporters". Why does currency exchange rate have any effect at all on the price of goods?

Let's say I own a widget factory producing widgets that each have a value of 10 lirettos, and my business is to export these to America for 11 lirettos each. Then one day, my government has some sort of scandal and the liretto/dollar rate falls from 0.2 USD per liretto to 0.1 USD per liretto. The newspapers congratulate me - now that my price is half of what it used to be, my export widgets should sell like hot cakes! However:

  • Americans were happy paying $2.2 per widget. Why would I suddenly charge them $1.1? American widget enthusiasts aren't suddenly going to start wanting widgets only half as badly just because a liretto isn't as valuable now. I would just export at 22 lirettos instead of 11.
  • My expenses wouldn't stay the same either. Maybe the liretto isn't worth as much now, but an hour of work is still an hour of work. If I tried to pay my workers the same nominal amount, even though it's worth half as much now, they would be outraged. They read the news too, after all.
  • Some of the materials I use to make widgets are imported anyway. Just like my American customers who don't demand cheaper widgets all of a sudden, my material suppliers won't give me an "inflation discount". They will expect me to pay twice as many lirettos per unit good, since the lirettos are now worth half as much.

I don't see how the currency exchange rate would affect anything at all. Most people in countries with fluctuating currency are aware of exchange rate trends. Everyone should be simply adjusting their prices and price expectations in proportion to the change in value. Maybe if the government decides to be stubborn, the purchasing power of public employees would change and impact the consumer demand within the country. But import/export businesses should be the least affected. Why then is it said that currency rate changes have an effect on imports/exports? Do international trade companies fail to keep up with changes in currency rates?

closed as off-topic by ChrisInEdmonton, Rupert Morrish, Chris W. Rea, NL - Apologize to Monica, Bob Baerker Jul 30 at 21:33

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My expenses wouldn't stay the same either. Maybe the liretto isn't worth as much now, but an hour of work is still an hour of work. If I tried to pay my workers the same nominal amount, even though it's worth half as much now, they would be outraged. They read the news too, after all.

Your workers have a contract stating that they will paid X lirettos an hour, and most likely they do not have any clause tying it to the USD exchange rate.

If due to the devaluation foreign imports cost more and that means that inflation hits your workers, they will begin asking for a bigger salary, but that will depend a lot of the situation (how many foreign goods do they consume? are your workers still able to make a living? do they have the option to be employed elsewhere at a higher rate?) and there will be a considerable delay.

When things like those happen there is often considerable social unrest as the people is forced to adjust their standards of living (for example, the 1998-2002 Argentine great depression).

Of course if the social crisis becomes so important to cause a social breakdown (let's get pessimistic and say that it sparks a civil war), then most likely it would not be a positive outcome for you or your business.

Americans were happy paying $2.2 per widget. Why would I suddenly charge them $1.1? American widget enthusiasts aren't suddenly going to start wanting widgets only half as badly just because a liretto isn't as valuable now. I would just export at 22 lirettos instead of 11.

As your local costs (wages, locally produced imports) have stayed the same or at best they will not have multiplied by 2, your costs will have gone down. But so will have the costs of your competition. If you keep your prices too high I will buy the widgets from your neighbour.

Of course, as an importer/retail store owner, maybe I will buy the cheaper widgets and still charge the consumer for $2.2, if nobody tries to compete with me. Profit! $$$$$ Or, if you are the producer but also control the supply chain, you will pocket the extra profits while telling your workers that these are hard times for everybody.

Some of the materials I use to make widgets are imported anyway. Just like my American customers who don't demand cheaper widgets all of a sudden, my material suppliers won't give me an "inflation discount". They will expect me to pay twice as many lirettos per unit good, since the lirettos are now worth half as much.

Of course, depending of how much of your costs are linked to imports the effect of the devaluation will be different on your costs.

  • On the third point, if the business model makes any sense, then the cost of the imported raw materials will be less than the price of the finished goods. So the OP still sees gains, albeit less than if all their raw materials were sourced locally. – Simon B Jul 30 at 11:39
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    Good answer so I will just add- on the second point. OP" "Americans were happy paying $2.2." Yes, the enthusiasts were. Now the casual users, the curious, the enthusiasts who could not afford $2.2 will jump in at $1.1 and your market will grow. The enthusiasts who bought 10 a month will by 20 or 30.So you can up your price and get the same volume at a higher profit, or keep your price, which makes it lower in USD and get a higher volume for a higher total profit. Either way you win. This is a bit risky, because then widget enthusiasts will expect their widgets at $1.10 a piece always. – Damila Jul 30 at 14:18
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Partially this depends on how you setup your business and your accounting. You probably run your local business in liretto. How currency fluctuations affect you and who carries the risk/reward when it happens, depends on how you sell your product. There are three major scenarios

You sell to an exporter than pays you in liretto There is no difference to your business unless you re-negotiate the price and current contract.

You sell to an exporter that pays you in US$, Euro, Pounds etc. That's the most common setup for, say, Chinese contract manufacturer. In this case you win when the dollar goes up or you lose when the dollar goes down.

You sell directly to the end consumer That's more complicated since you also need to operate a footprint in the US. So part of your cost fluctuate with the currency and the revenue does to. This typically lands somehwere in between the two extremen cases above.

In reality currency fluctuates continuously but in relatively minor amounts and your business will benefit or suffer depending on the setup and on the direction of fluctuation. Only large fluctuations will actually trigger price changes and/or renegotiation of contracts, but that happens pretty rarely

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