What Is Currency Devaluation?

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Currency devaluation takes place when one country's currency is reduced in value in comparison to other currencies. After currency devaluation, more of the devalued currency is required in order to purchase the same amount of other currencies. A fictional example: If last year, one U.S. dollar purchased 10 Mexican pesos, then this year, one U.S. dollar can only purchase five Mexican pesos, the U.S. dollar has undergone a currency devaluation.

Origins

  • Currency devaluation can take two forms. It can either be the natural result of market forces, or it can be the result of government intervention. In the first scenario, the global market changes its opinion about the stability, value or future of a currency and decides that it is willing to pay less. In the second scenario, a nation's government fixes the relative price of their currency below its present level and prohibits currency exchange at any other rate.

Benefits

  • Currency devaluation can help to achieve a more desirable balance of trade. For nations experiencing a trade deficit (when imports exceed exports), a currency devaluation will reduce the price of their products abroad and increase the price of foreign products in domestic markets. Increased demand for products in other countries due to lower prices can also mean more jobs and lower unemployment rates at home.

Drawbacks

  • Currency devaluation also has negative consequences. Individuals holding a recently devalued currency have lost international buying power. Their ability to purchase goods or services from other countries has diminished. Additionally, if a government artificially devalues its currency, it may be forced to purchase its own currency with foreign reserves, depleting its own assets and ability to pay public debt. This occurred in Russia after its 1998 currency crisis.

Argentina

  • In 2001, the Argentine peso was pegged to the U.S. dollar. One peso was equal to one dollar. However, the government grew increasingly unable to pay its public debt and in the beginning of 2002, the government devalued the peso. While the initial effects were chaotic, leading to rampant unemployment and poverty, they have improved. Unemployment and poverty have diminished, and exports as a percentage of gross domestic product have skyrocketed.

United States

  • Between 2002 and 2009, the U.S. dollar has been devalued, although the change has taken place more slowly than in Argentina, and from market forces rather than government edict. In 2002, one euro cost about $0.86. In August 2009, the price reached $1.41. This resulted in a decrease in Americans traveling in Europe and buying European products and an increase in Europeans traveling to the U.S. and buying U.S. products. The same effects on the U.S. dollar took place in the United Kingdom with the British pound, Japan with the yen, and Canada with Canadian dollars.

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