Devaluation

Devaluation

A devaluation is a tool used by the monetary authorities to improve the country’s trade balance by increasing exports at a time when trade deficits can be a problem for the economy. Countries that have a fixed exchange rate or a semi-fixed exchange rate use this monetary policy tool. This is often confused with devaluation and the opposite of reconstruction which refers to the rearrangement of currency exchange rates. Investors in those countries have suffered losses both through currency devaluations and declines in local stock markets. As a result, some Asian markets have lost 90% in dollar terms over the past few months. A financial authority maintains a certain value of its currency by being willing to buy or sell foreign currency with domestic currency at a fixed rate; The devaluation is an indication that the monetary authority will trade foreign currency at a lower price. Thus, its trade will be more balanced and its balance of payments will be improved. Undervaluation will not be effective if the outstanding non-payment is the result of a fundamental structural error in a country’s economy.

Exports become cheaper and more competitive for foreign buyers. Therefore, it increases domestic demand and can create employment in the export sector. Depreciation reduces a country’s export costs, makes them more competitive in the global market, which increases the cost of imports, so domestic consumers are less likely to buy them, and strengthens domestic trade. As exports increased and imports declined, they narrowed the trade deficit in favor of a better balance of payments. Degradation is a more destructive way to restore competition than ‘internal devaluation’. Internal devaluation relies on deflationary policies to reduce prices while reducing overall demand. Depreciation can restore competition without reducing overall demand. This means that a country devaluing its currency could reduce its deficit due to the strong demand for cheap exports from a cheap country. A large and rapid devaluation could scare international investors. This makes investors less interested in holding on to government debt because devaluation effectively lowers the real value of their holdings. In some cases, rapid devaluation can trigger capital flight.

Related but distinct concepts include inflation which is a market-determined decline in the value of money in the case of goods and services. Deterioration can have a lot of negative effects. Inflation may rise. Foreign debt services become more difficult to pay and they reduce people’s confidence in their currency. Changing the currency without reducing the exchange rate is not re-election, devaluation, or reconstruction.

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