Why currency devaluation

Under a fixed exchange rate system, only a decision by a country's government or monetary authority can alter the official value of the currency. Governments do, occasionally, take such measures, often in response to unusual market pressures.

Devaluation , the deliberate downward adjustment in the official exchange rate, reduces the currency's value; in contrast, a revaluation is an upward change in the currency's value. For example, suppose a government has set 10 units of its currency equal to one dollar.

To devalue, it might announce that from now on 20 of its currency units will be equal to one dollar. This would make its currency half as expensive to Americans, and the U. To revalue, the government might change the rate from 10 units to one dollar to five units to one dollar; this would make the currency twice as expensive to Americans, and the dollar half as costly at home.

When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency's fixed exchange rate untenable.

In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.

A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies. There are two implications of a devaluation. First, devaluation makes the country's exports relatively less expensive for foreigners. Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports. Necessary cookies are absolutely essential for the website to function properly. These cookies ensure basic functionalities and security features of the website, anonymously.

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Performance Performance. Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors. Because exports increase and imports decrease, there is typically a better balance of payments because the trade deficit shrinks. In short, a country that devalues its currency can reduce its deficit because there is greater demand for cheaper exports.

In , Guido Mantega, Brazil's Finance Minister, alerted the world to the potential of currency wars. While some countries don't force their currencies to devalue, their monetary and fiscal policy has the same effect, and they remain competitive in the global marketplace for trade. Monetary and fiscal policies that have a currency devaluing effect also encourage investment, drawing in foreign investors to cheaper assets like the stock market.

The Trump administration responded by labeling China a currency manipulator. This was just the latest salvo in the U.

China trade war , but certainly not the first time China had devalued its currency. While devaluing a currency may be an attractive option, it can have negative consequences. Increasing the price of imports protects domestic industries, but they may become less efficient without the pressure of competition. Higher exports relative to imports can also increase aggregate demand , which can lead to higher gross domestic product GDP and inflation.

Inflation can occur because imports become more expensive. Aggregate demand causes demand-pull inflation, and manufacturers may have less incentive to cut costs because exports are cheaper, increasing the cost of products and services over time.

China has been accused of practicing a quiet currency devaluation and attempting to make itself a more dominant force in the trade market.

Some accused China of secretly devaluing its currency so it could revalue the currency after the presidential election and appear to be cooperating with the United States. However, after assuming office, U. President Donald Trump threatened to impose tariffs on cheaper Chinese goods partly in response to the country's position on its currency. Some feared that this may lead to a trade war, putting China in a position to consider more aggressive alternatives if the United States followed through.

Egypt has faced constant pressure from U. The Egyptian stock market responded favorably to devaluation. However, the illegal market responded by depreciating the exchange rate of the U. The Guardian. The New York Times. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.

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