What Is Devaluation and What Does It Mean for Traders?

Devaluation is the intentional process of reducing the currency value. As a rule, it is launched by the country’s government to prevent markets from determining the value of the issued currency against a stronger one. Another reason for devaluation is the increase of gross domestic product that defines the level of economic activity within the borders of a particular nation.

In this article. We will discuss the major reasons for devaluation as well as how good or bad it can be for the currency. You will also learn the examples of devaluation and ways it may affect the economic situation.

Major Reasons for Currency Devaluation

At some point, the government will have to take measures to decrease domestic products’ prices making them cheaper for foreign buyers. On the other hand, residents will have to face a rapid price increase. The situation results in growing exports and falling imports. In the end, it is supposed to lead to economic growth in the future.

In other words, the policy of devaluation can be considered a mercantilist strategy that has proved to be an effective way to retrieve the economical balance during the Great Depression. Today, the policy is mainly utilized by countries with emerging economies, as it attracts a bigger number of foreign investors seeking cheaper products an established economy cannot offer. At the same time, residents face price increases at lower incomes, which means fewer negative consequences.

Devaluation Example

Let’s say, you can buy 1 US dollar for 1 Panama balboa. However, the Panama government may decide to change the exchange rate followed by a 50% devaluation. For consumers, it means that 1 US dollar will cost 2 Panama balboas.

Currency Devaluation Pros and Cons

To understand all pros and cons of devaluation, we need to identify those who can benefit and lose from the process. On the one hand, we have domestic companies and foreigners that can bear fruit from currency devaluation. On the other hand, we have country’s citizens who may suffer from negative consequences:

• Winners – foreign companies that witness an increased demand for products because of lower prices. It will also mean the need for more production capacity and labor resources, which results in more jobs for residents. Imported products are cheaper for other countries. Foreigners can spend more money on other things.
• Losers – foreign residents benefit from cheaper products followed by the decreased need for domestic goods. It means fewer job opportunities, while domestic residents will need to save funds or find a more cost-effective substitution.

What Is Currency Revaluation?

Revaluation is the process to oppose devaluation. It means that the government decides to change a fixed rate and make its currency more expensive against a stronger one. Revaluation will make products expensive to both foreigners and country residents.

Currency Wars Explained

Currency wars are used by countries to manipulate the currency value against another one. Experts believe that such an approach makes it possible to boost the currency trading dynamics, which inevitably results in devaluation in another country. While the exchange rate goes back and forth, the economy of both countries is weakening.

Some countries are believed to use this tool to enhance economic activities within their borders and bring unemployment and a degraded economy to others. However, a full-scale currency war has never been officially detected or stated.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.