Nominal and Real Exchange Rates for chile, 1979-1982
An 18% “corrective” devaluation was enacted in June 1982. Overall, the peso fell 90% over the next 12 months. However, the artificially high peso had already done its double damage to the Chilean economy: It made Chile’s manufactured products more expensive abroad, pricing many of them out of international trade, and it made imports cheaper, undercutting Chilean domestic industries. The effects of the overvalued peso were devastating. Banks became insolvent, factories and copper smelters were thrown into bankruptcy, copper mines were closed, construction projects were shut down, and farms were put on the auction block. Unemployment approached 25%, and some areas of Chile resembled industrial graveyards.
The implosion of the Chilean peso did have a silver lining: Chilean companies became dynamic exporters, which today sell chopsticks and salmon to Japan, wine to Europe, and machinery to the United States. It also sped the acceptance of free market economic policies that have given Chile one of the strongest growth rates in the world.
The Chilean example illustrates a critical point: An increase in the real value of a currency acts as a tax on exports and a subsidy on imports. Hence, firms that export or that compete with imports are hurt by an appreciating home currency. Conversely, such firms benefit from home-currency depreciation. These general principles identify a company’s economic exposure.
1 If the price is raised to $14, the profit margin is $6 ($14 − $8). However, at an exchange rate of R1 = $0.02, the real margin is still R300. With 100% inflation, the inflation-adjusted value of this margin is equivalent to only half of today’s margin of R300 (R2 at year’s end has the purchasing power of R1 today).