Currency devaluation is a government-sponsored reduction in the value of a country’s currency on global markets, making its exports less expensive and its imports more expensive. It’s a key tool in a nation’s economic arsenal, designed to boost exports and reduce trade deficits and debt loads. However, there are risks to this type of policy that can have global repercussions and create uncertainty for investors.
Historically, money was made from precious metals, such as gold, silver and bronze, and it had a defined value that was redeemable for those metals. A government short of precious metals could devalue its currency by decreeing that coins had less value or by simply printing more paper. This was known as competitive devaluation because it was intended to improve a country’s position on the world market by competing with its trading partners for foreign investment and trade.
More recently, countries use a variety of tactics to influence the value of their currencies on world markets, including lowering interest rates, changing reserve requirements and directly intervening in the foreign exchange market. These policies are collectively called monetary devaluation and can have both positive and negative effects on a country’s economy and its trading relationships.
Another method of currency devaluation is fiscal devaluation, which is done by lowering direct taxes on production and raising indirect taxes such as value added tax (VAT), which isn’t charged on exports. However, this type of devaluation has the same effect as currency devaluation and can be a risky tactic for international markets because it can cause other countries to respond with their own devaluations in a “beggar thy neighbor” strategy that may trigger a global market crisis.