What is currency devaluation? Why is it used as a monetary tool? What is the economic impact of devaluation? These are three key questions I will try to address in this week’s piece.
First, currency devaluation is the deliberate act by a government of adjusting downward a country’s currency relative to another currency or currencies. An example would be that $1 buys 5 XYZ dollars, but after a devaluation, $1 would buy 10 XYZ dollars. In this example, the dollar has strengthened by 100 percent, while the XYZ dollar has been devalued by 50 percent.
How is currency devaluation used as a monetary tool? Currency devaluations can potentially help reduce a trade deficit and make domestic companies more competitive. By devaluing a country’s currency, it makes their exports less expensive and imports more expensive. The hope is that devaluation results in a significant increase in exports, as outside buyers can afford more, and a decrease in imports. The result is an increase in capital coming in.
What is the economic impact of currency devaluation? While currency devaluation may sound beneficial as it can help reduce a trade deficit, improve the competitiveness of domestic corporations, and reduce interest payments on debt, devaluation can also lead to instability. Consider the uncertainty that an all-out currency war could break out, resulting in rising inflation due to the higher cost of imports and wage pressure given that other countries may be more attractive to employers from a wage standpoint. In the current environment, a currency devaluation may be used as a way to offset the impact from the imposed tariffs.
