Loading the player...

What is the 'J-Curve Effect'

The J-curve effect, in economics, is the phenomenon where a country’s balance of trade initially worsens following a devaluation or depreciation of its currency, before it recovers to a higher level than where it started. J-curves are also observed in other fields, such as medicine, political science and in private equity, where an initial loss is followed by a significant gain.

BREAKING DOWN 'J-Curve Effect'

The J-curve effect is observed in trade balances because the weaker currency initially translates into more costly imports and cheaper exports, leading to a bigger initial trade deficit or a smaller surplus. However, because the affected country's exports are now cheaper in currency terms, they start to rise as foreign demand for the lower-priced option increases. Local consumers also purchase fewer of the now more expensive imports and substitute them with comparable local goods which have now become more affordable. As a result, the trade balance eventually recovers and bounces back to a higher level than it was at before the exchange rate dropped. The lag is caused by the fact that importers and exporters have to honor pre-existing contracts, so the trade volumes initially remain unchanged even though the exchange rate and relative prices have changed.

When a country’s currency appreciates, a reverse J-curve may occur. This happens because the country’s exports initially become more expensive for importing countries than they were before. If other countries are able to offer the good at a more affordable rate, the stronger currency will reduce its export competitiveness may see demand for its exports fall. Additionally, local consumers may switch to imported versions of goods if they are suddenly cheaper.

J-Curves in Private Equity Funds

In private equity, funds tend to experience negative returns in the first few years, when there are upfront investment costs and management fees, and underperforming portfolios are often written off. There are often capital drawdowns and the internal rate of return of an investment drops until it stabilizes and then in the later years posts increasing returns as the investments mature. If the fund is well managed, it will eventually recover from its initial losses and the returns will form a J-curve.

The J Curve effect is quite pronounced in the United States, as private equity funds tend to carry their investments at a lower market value. The funds tend to write down the carrying value of any underperforming investments, more than they write up performing investments. The value of the profitable investments is only recognized when the private firms go public or are sold in an M&A deal.

RELATED TERMS
  1. J Curve

    A theory stating that a country's trade deficit will worsen initially ...
  2. Net Exporter

    A net exporter is a country or territory whose value of exported ...
  3. Trade Surplus

    A trade surplus is an economic measure of a positive balance ...
  4. Balance Of Trade - BOT

    The balance of trade is the difference between a country's import ...
  5. Trade Deficit

    A trade deficit occurs a country's imports exceeds its exports. ...
  6. Competitive Devaluation

    A series of sudden currency depreciations that nations may resort ...
Related Articles
  1. Investing

    Private Equity: Understanding the J-Curve Effect

    Investors considering private equity need to understand what the J-curve effect is and how it works.
  2. Insights

    Interesting Facts About Imports and Exports

    Learn how imports and exports exert a profound influence on the consumer and the economy.
  3. Investing

    What's the Balance of Trade?

    The balance of trade is the difference between the value of all the goods and services a country exports and the goods and services it imports.
  4. Trading

    6 factors that influence exchange rates

    Here, you'll get in-depth look at out how a currency's relative value reflects a country's economic health and impacts your investment returns.
  5. Trading

    Main Factors that Influence Exchange Rates

    The exchange rate is one of the most important determinants of a country's relative level of economic health and can impact your returns.
  6. Trading

    The Hazards Of Currency Movements

    Devaluation and revaluation are official changes in the value of a nation’s currency in relation to other currencies. The terms are generally used to refer to officially sanctioned changes in ...
  7. Insights

    The Pros & Cons of a Trade Deficit

    Is a trade deficit, also known as a current account deficit, beneficial or detrimental to a country's economy?
  8. Investing

    Grasp the Accounting of Private Equity Funds

    Read about private equity accounting and how it is different than that of other investment vehicles. The nature of private equity makes a difference.
  9. Trading

    Drastic Currency Changes: What's The Cause?

    Currency fluctuations often defy logic. Learn the trends and factors that result in these movements.
  10. Investing

    What Is A Currency War And How Does It Work?

    We look at what a currency war is, what factors may lead to it, the impacts of such a strategy, and whether there is a currency war currently.
RELATED FAQS
  1. Which factors can influence a country's balance of trade?

    Find out about the factors that affect a country's overall balance of trade and how it is used as an economic indicator. Read Answer >>
  2. What is a trade deficit and what effect will it have on the stock market?

    Learn what is a trade deficit is, also known as net exports, and what effect they have on the stock market. Read Answer >>
  3. How does inflation affect the exchange rate between two nations?

    Countries attempt to balance interest rates and inflation, but the interrelationship between the two is complex and can influence ... Read Answer >>
  4. What are key economic factors that can cause currency depreciation in a country?

    Read about the causes of currency devaluation, and find out how to differentiate between relative and absolute currency devaluation. Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center