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A currency devaluation occurs when the currency of a country loses value during an adjustment in comparison to the currencies in other countries. When this situation happens, it has an important effect on the world economy. Assets in that country become cheaper for foreign people, and exports increase for the country. The trade balance between countries changes as a result.
Currency manipulation and currency wars
A similar effect occurs when a government decides to use currency manipulation. It means that it lowers the value of their currency. It works as a strategy to boost up their economy and make it stand over their fellow countries, promoting tourism and investment in their businesses. When a country does it on purpose, it forces other countries to lower their currency, too, which can lead to a currency war.
Currency wars can be beneficial for the country that starts it but can disbalance the world economy with the devaluation of currencies.
Why would a country weaken its currency?
A weakened currency can be problematic, causing inflation to increase in the country’s economy. However, some of the consequence of lowering the currency is helpful in the long view. With a weak currency, exportations of the products become more competitive, because foreign companies will invest in those products that will be at lower prices.
It can also help to manage the government debt because it lowers the amount on the loans that the country has with the weakened currency. It promotes foreign investment in national companies and makes it an interesting tourist option for those who wish to have a different vacation. People from other countries will travel to those places where the expenses are smaller, so tourism improves.
It creates competition with other countries that export the same products, lowering the prices that the other countries would need to match to be able to keep up. These other countries, then, will have to weaken their currency to be able to compete with the prices.
And though inflation is usually related to a bad economy, if the government finds means to manage it correctly, it can boost up the cost of living.
What could happen after devaluing currencies?
Depending on the country and the moment it decides to weaken its currency, it can be disapproved by the international community. Devaluing currencies always comes with the risk of creating a currency war, which can damage the world’s economic system.
Relationships between countries can worsen, and the high cost of living for the country citizen can provoke discomfort. People will protest, and it can bring the government to a precarious state.
How do countries manipulate their currencies?
The central bank of the country manages currency manipulation. It can take many actions, like increasing the supply of currency in the international market. With this action, the currency is easier to obtain, so its value decreases.
They can also purchase certain assets, and sell their currency - supporting the value of other currencies. They can also control the in and out of capital flow, such as limiting its entrance.
