Currency Devaluation: Methods and Reasons

The average person would probably expect a country to want to increase its currency’s strength, so it could perform better with trade and buy more. However, for a variety of reasons, governments around the world intentionally make adjustments to their currencies, affecting its value versus other currencies. The process and reasoning behind it can be simple or complex.

The Process

The fastest way to devalue a currency is through inflation. When inflation occurs, it takes more currency to buy the same product or service. The value of the currency unit becomes less relative to goods and prices people charge. For a government, normally inflation is something it doesn’t want because it can destabilize the local market. However, if the country begins to print more currency, it makes more units available. In doing so, more currency is available on the market based on the country’s production or value. This makes the currency cheaper in relation to other countries.

Alternatively, a government could make lending easier by lowering borrowing rates. When this occurs, it floods the country’s market with more money as more loans occur. People have money, they spend and more currency hits the street and circulates. This in turn can also devalue a currency while the lending continues. However, when the borrowing dries up as rates again increase, the remaining dollars will eventually dwindle and increase in value. So the effect is temporary.

Finally, a government could arbitrarily dictate that its currency is worth less. However, especially now in a global market, doing so can cause significant havoc and isolation of the country from others countries’ markets. For trade to work and flourish, countries need to respect and be mindful of each other. The currency relationship needs to flow on its own rather than be influenced by arbitrary rate-setting. Arbitrary currency devaluation can quickly make economic enemies a country doesn’t need.

Reasons

One of the main reasons a country devalues its currency is to increase its ability to bring in production from the outside and boost its own labor and development. When outside currencies are much stronger, a country can attract international business with cheaper production and labor costs by having a lower valued currency.

Alternatively, a country may want to recover its currency from overseas holders. By devaluing the currency it becomes worth less and cheaper to buy back. They country can then re-inflate the value again over time to bring it back to its original state, however it’s no longer sitting overseas.

Finally, a country may want to devalue its currency to pay off international debt. If its original loans were made in the same currency, the country could devalue the monetary value by printing more to then pay off the loan faster. This approach gets the borrower country out of the debt that may be pulling financial resources away and becoming a burden.

Conclusion

Currency devaluation is only one tool of a number of ways countries manipulate their currencies in relation to other countries. However, in some circumstances, it can be a very powerful tool. That said, devaluation can also cause political strife between markets. So it needs to be handled carefully.