Each country enacts policies to manage its currency and control inflation. With respect to international trade, the relative value of a country’s currency will make buying or selling items more or less expensive, which significantly impacts its economy. Here’s an overview of some common reasons that would motivate a country to devalue its currency.
What Is Currency Devaluation?
The idea of currency devaluation itself is straightforward. It simply describes a country’s choice to intentionally lower the value of its money in comparison to the value of other currencies. The process of devaluing a currency is a bit more complex. Usually, a central bank will sell a large amount of its own currency in foreign exchange markets to increase the currency’s supply. Because there isn’t a proportional increase in demand for that currency, it becomes less valuable in the global market.
The Effects of Devaluation
As a country’s money becomes less valuable than the currencies of other nations, it will be more expensive for its citizens to buy foreign products and domestic items made with materials from other countries. However, prices should remain relatively stable for service-based industries and products that are made with local materials.
Why Would a Country Devalue Its Currency?
Central banks often use devaluation to address a trade imbalance with another country. As mentioned earlier, devaluation makes imports more expensive for a country’s citizens. This encourages people to buy domestic products and makes the country’s exports cheaper for foreign consumers. Both of these outcomes benefit local manufacturers and workers by allowing them to sell more products at home and abroad. Devaluation can become a source of tension between countries if it appears to be blatant market manipulation. China has been accused by the U.S. and other nations of keeping its currency (the yuan) artificially low by devaluing it numerous times in the past decade. The term “currency manipulator” is oftentimes used by politicians and others when referring to countries that are purposely devaluing their currency in an attempt to strengthen their export position with respect to world trade.
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