Chinese 100 yuan banknotes are seen in this picture illustration taken in Shanghai
Chinese 100 yuan banknotes in Shanghai, January 17 , 2011. REUTERS

Policymakers are operating under the fallacy that the lower the value of one's currency is, the better it is for the economy.

Their assumption is based on the premise that cheap currencies make exports competitive, so by devaluing their currency, they create businesses and jobs in the exporting sector. This assumption is correct.

However, the famous saying there is no free lunch also applies in this situation and there is a heavy price to pay for having a cheap currency.

Cheap currencies make imports more expensive. It also makes it more expensive to purchase domestically-produced goods because local buyers need to compete with international buyers who have the advantage of an overvalued currency.

Essentially, the society at large gives up its purchasing power in order to subsidize the exporting sector. This practice, however, defeats the original purpose of economic growth, which is to enrich people materially.

To use an analogy, persistently undervaluing one's currency to boost exports is like taking a more demanding job without receiving a matching pay raise.

Another problem is that subsidies bloat industries.

For countries with undervalued currencies, the exports industry is bloated with inefficient players and sectors that don't enjoy comparative advantages.

Without the currency subsidies, these companies would be bankrupt. With the subsidies, they're barely profitable and represent a bad and inefficient use of resources.

Furthermore, these companies are unsustainable because currencies can't be undervalued forever.

Once cheap currencies appreciate to fair value, these subsidized companies likely go bankrupt; when that happens, the resources poured into them will be wasted and society will suffer massive job losses.

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