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Devaluing Currencies Could Be More Helpful Than You Think

When you think of the word devalue, you would think of something negative. This is logically so because it literally means losing the value. So why would countries devalue their currencies? Well, it’s simple: because despite its connotations, there are immense benefits gained from doing it.

Just recently, Trump accused the second largest economy of the world of currency manipulation. China has vehemently denied it but the fact is their currency, the yuan, is devaluing. They are even being blamed for the global uncertainty in the markets. Whether it’s deliberate or not, it is advantageous for China. With all that’s happening, some countries still push for the devaluation because of the following reasons.

1. Bolster Exports

Devaluation means that the goods of one country is significantly cheaper compared to the same goods of another country. Basically exports become more competitive in the global market. An example is given by Investopedia. “Car makers in America must compete with car makers in Europe and Japan. If the value of the euro decreases against the dollar, the price of the cars sold by European manufacturers in America, in dollars, will be effectively less expensive than they were before. On the other hand, a more valuable currency make exports relatively more expensive for purchase in foreign markets. “

While this is a good way to boost exports, moderation is advised. If one country devalues its currency, others might want to follow to keep their products in the spotlight. Excessive devaluation means an increase in demand for that country’s products. This could lead to higher prices and eventually inflation.

2. Lower Trade Deficits

When exports are cheap, chances are there’s higher demand for that product. This means imports are lower and exports are higher thus lowering trade deficits. This is an important issue because unchecked deficits could create a problem for a growing economy. However, as in the case of the boosted exports, too much devaluation to lower trade deficits could also spell disaster. Too much of it could cause lower confidence in the local currency.

3. Lessen Sovereign Debt

Currency devaluation could prove to be helpful for the sovereign debt of a government. Nations with fixed debt payments are able to pay cheaper in the long run. An example in Investopedia explains this concept perfectly. “Take for example a government who has to pay $1 million each month in interest payments on its outstanding debts. But if that same $1 million of notional payments becomes less valuable, it will be easier to cover that interest. In our example, if the domestic currency is devalued to half of its initial value, the $1 million debt payment will only be worth $500,000 now.”

This advantage is balanced, of course, by the risk of too much devaluation as in the case of the first two above. The problem with devaluing the currency and making sovereign debts cheaper is the fact that other countries can do the same too. It then becomes a race to which one can devalue faster. In the end, the whole global economy can come into recession due to inflation.

In the end, devaluation is only recommended for times of need and not for consistent use. It is a double-edged sword that can destroy the balance of the country and possibly the world.

Created by : Chuck
Published : 16 Mar 2017

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