On Undervalued Currency

by Don Boudreaux on October 4, 2009

in Balance of Payments, Seen and Unseen, Subsidies, Trade

When I was a kid, my elementary school — Immaculate Conception School (ICS), in Marrero, LA — held two fund-raising fairs each year, one in the Fall, the other in the Spring.  At these fairs, we kids bought tickets that we could exchange for various toys, trinkets, and food sold at the fair.  Of course, some items cost more tickets than did other items.  A big stuffed panda bear might have been priced at, say, 50 tickets, a hot dog at three tickets, and a pencil sporting the school logo at one ticket.

Using dollars, each of us students could buy as many or as few tickets as we pleased (or, more accurately, as many tickets as our parents could afford or would allow us to buy).

Why we weren’t allowed to purchase the items directly with our U.S. currency, rather than having to first exchange our dollars for ICS tickets, I don’t know.  But dems’ da facts.

Suppose that ICS (my school) had undervalued its tickets.  Say, if the ‘correct’ (by whatever calculus) price of each ICS ticket was $1.00, suppose my school sold each ticket for $0.75.

Undervaluing its currency in this way surely would have resulted in more sales at the fairs.  A twenty-five percent discount on toys, trinkets, and hot dogs and popcorn is a darned attractive deal for kids.

Would ICS have benefitted itself by such undervaluation of its medium of exchange?  Some of its employees would have benefitted — the fairs, for example, would have required more clerks and food preparers to handle the larger demand.  But it’s clear that undervaluing these tickets would have cost ICS on net.  Instead of raising money for its operations, ICS would have lost money.  It would have subsidized its students’ consumption of toys, trinkets, and junk food.  Undervalued tickets would have enabled its customers (us students) to acquire valuable goods and food at prices below ICS’s cost of supplying these goods and food.

I’m certain that no student (including me) would have complained about undervalued fair tickets.  Such undervaluation would have been to our benefit.

But the school principal — who we can imagine was the architect of this self-destructive scheme — would have realized, upon coming to his or her senses, that artificially stimulating the school’s exports of toys, trinkets, and food on fair days, was no path to long-run and widespread prosperity for ICS.

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