Hard-Currency Policy

Money usually loses value over time. For 100 euros you get less today than you did ten years ago, because prices have risen. However, a state can allow this loss of value to occur to a greater or lesser degree. Hard-currency policy means: the state and its central bank – that is, the state authority that issues money and sets interest rates – deliberately keep the value of their own currency high. In doing so, they accept that the economy will grow more slowly. The opposite is a soft currency, whose value is deliberately allowed to fall in order to make goods cheaper to offer abroad.

What a hard currency brings the country

The most important advantage is price stability. If a currency remains stable, imported goods do not become more expensive. Germany, for example, imports almost all of its crude oil, and oil is paid for in US dollars worldwide. If one’s own currency is strong, the same amount of oil costs less. This dampens inflation, that is, the general rise in prices, throughout the country.

The second advantage is trust. Anyone investing money internationally does not want their wealth to shrink due to a loss in the currency’s value. A country with a hard currency therefore finds it easier to obtain loans and pays lower interest rates on them. Switzerland is the classic example of this: in times of crisis, investors literally flee into the Swiss franc.

There is, however, a downside one must be aware of. A strong currency makes exports expensive. A German car costs an American buyer more if the euro is strong. Export industries thereby come under pressure, and in weak economic phases this can cost jobs.

The central bank’s tools

The most important instrument is the key interest rate. This is the rate at which ordinary banks can borrow money from the central bank. If the central bank raises it, loans become more expensive throughout the country. At the same time, it becomes attractive for foreign investors to put money into this currency, because they receive good interest rates for doing so. Demand for the currency rises, and with it its value.

A second tool is direct intervention in the foreign exchange market, that is, the place where currencies are traded against one another. The central bank buys its own currency using its reserves of foreign money. This drives the exchange rate up. However, this tool only works in the short term, because reserves are limited.

In addition, there is a point that is often overlooked: sound public finances. A state that constantly takes on new debt will sooner or later be tempted to devalue its debt through inflation. Investors know this and demand compensation for it. That is why budget discipline is part of a hard-currency policy.

From the Deutsche Mark to the ECB

The best-known example in Germany is the Deutsche Bundesbank before the introduction of the euro. It was regarded worldwide as uncompromising when it came to the value of money, and raised interest rates even when the government did not want it to at all. This turned the Deutsche Mark into one of the hardest currencies in the world. This stance was deliberately carried over into the European Central Bank, which manages the euro today.

In the news, the topic usually comes up in connection with interest rate decisions. When the ECB or the American central bank, the Fed, raises interest rates to fight inflation, the same logic lies behind it. Disputes over whether a central bank may make decisions independently of the government also belong in this field.

A common misconception is that a hard currency is automatically good for everyone. For consumers and savers, this is usually true. For export companies and for heavily indebted states, it can become a heavy burden. This is precisely what is regularly the subject of political dispute in Europe.