Understanding devaluation

Devaluation is the deliberate downward adjustment of the value of a country's money relative to another currency, group of currencies, or currency standard. Countries that have a fixed exchange rate or semi-fixed exchange rate use this monetary policy tool. It is often confused with depreciation and is the opposite of revaluation, which refers to the readjustment of a currency's exchange rate.

The government of a country may decide to devalue its currency. Unlike depreciation, it is not the result of nongovernmental activities.

One reason a country may devalue its currency is to combat a trade imbalance. Devaluation reduces the cost of a country's exports, rendering them more competitive in the global market, which, in turn, increases the cost of imports. If imports are more expensive, domestic consumers are less likely to purchase them, further strengthening domestic businesses. Because exports increase and imports decrease, there is typically a better balance of payments because the trade deficit shrinks. In short, a country that devalues its currency can reduce its deficit because there is greater demand for cheaper exports.

In 2010, Guido Mantega, Brazil's Finance Minister, alerted the world to the potential of currency wars. He used the term to describe the ongoing conflict between countries like China and the United States over the valuation of the yuan.

While some countries don't force their currencies to devalue, their monetary and fiscal policy has the same effect, and they remain competitive in the global marketplace for trade. Monetary and fiscal policies that have a currency devaluing effect also encourage investment, drawing in foreign investors to (cheaper) assets like the stock market.

On August 5, 2019, the People's Bank of China set the yuan’s daily reference rate below 7 per dollar for the first time in over a decade. This, in response to new tariffs of 10 per cent on $300 billion worth of Chinese imports imposed by the Trump administration, was set to go into effect Sept. 1, 2019. Global markets sold off on the move, including in the United States, where the Dow Jones Industrial Average (DJIA) lost 2.9 per cent on its worst day of 2019 up to that date.

While devaluing a currency may be an attractive option, it can have negative consequences. Increasing the price of imports protects domestic industries, but they may become less efficient without the pressure of competition.

Higher exports relative to imports can also increase aggregate demand, which can lead to higher gross domestic product (GDP) and inflation. Inflation can occur because imports become more expensive.

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