Few prices are as important as foreign exchange prices. World markets respond to shifts and economic changes in government funds in a complex system of exchange rates. In many cases, the appreciation or depreciation of a national currency is used as an instrument of economic policy. In other words, it is currency manipulation. Changes in the value of a currency affect all markets differently around the world.
What is devaluation?
Devaluation (Deval) is the process by which a country's currency loses its value in relation to a foreign currency (Foreign Exchange — FX). This means that the purchasing power of that currency decreases. This can occur domestically without any serious consequences, or it can have a clear impact on the current account balance of the balance of payments.
Meanwhile, devaluation has a strong impact on all goods and services sold or purchased abroad: while it becomes more expensive to buy goods from abroad at home, for foreigners they become cheaper in that country.
Essentially, the forex market is just like any other market: supply and demand determine what happens and the price of the currencies traded. In this sense, they are always expressed in terms of another currency: trading takes place in currency pairs.
Deval’s example is the impact of the Brexit vote in 2016 on the value of the British pound. The pound experienced extreme volatility, and at some points depreciated significantly against the US dollar. An even more dramatic picture occurred in 1997, when the collapse of the Thai baht affected almost all Southeast Asian FX, causing them to lose significant value in one fell swoop.
Reasons for devaluation
This happens for various reasons:
- The internal inflation rate has increased: an increase in the money supply and an increase in the velocity of money circulation lead to a decrease in value.
- Interest rates are higher abroad: If key interest rates at home are low, it is easier for citizens and foreigners to borrow money. As a result, the value of the currency falls.
- Central bank intervention in the foreign exchange market: The central bank (also known as the central bank) constantly influences the foreign exchange and financial markets through manipulation. This activity affects interest rates and the value of the currency.
- Revaluation of another FX: Devaluation can also occur when a benchmark FX becomes more valuable. This is not a pure devaluation, but leads to similar effects.
- Quantitative Easing: The obvious tool used by the central bank is to inject cheap money into the market to influence the value of money. For example, government bonds are bought up and money becomes available.
- Economic policy: If a country is in recession, targeted Deval can lead to support for exports, tourism and investment in that country. Foreigners can spend more money and buy more goods. As a result, more money flows into the state treasury.
This has a mostly negative impact on citizens of the country if they want to buy foreign goods. Exporters, on the contrary, benefit.
Types of devaluation
It is caused by various reasons and can take several forms. The main types are:
1. Official (administrative)
It takes place by decision of state bodies, usually the central bank, the government. It is a controlled process aimed at changing the fixed exchange rate of the national currency.
2. Market
It occurs in a free foreign exchange market, when demand for the national currency falls and supply increases. The process occurs spontaneously, without direct state intervention.
3. Creeping
Characterized by a gradual depreciation of the exchange rate over a long period of time. This approach can be used to adapt the economy to new conditions.
4. One-time
A sharp, one-time devaluation of the exchange rate. Typically used in crisis situations to correct imbalances in the economy.
5. Hidden
It manifests itself through inflation. Formally, the exchange rate remains unchanged, but the purchasing power of money within the country decreases.
Each type of Deval has its own consequences that can affect the country's economy, exports, imports, and the standard of living of the population.
In history, there have been many cases of it for economic reasons. States have repeatedly tried to keep their currencies at a comparable level through currency manipulation. The reason for this is that devaluation does not always have to be in the interests of the country in question. While countries with strong exports, such as Germany and England, are exposed to the risk of revaluation, countries with weaker exports, such as the United States, are exposed to the risk of Deval.
The methods used to change the exchange rate are actually many and varied. For example, to change the demand and supply of a currency, a large amount of money can be put into circulation. In addition, money can be withdrawn from the market by selling government bonds, etc. This leads to more/less money appearing on the market.
Consequences of devaluation
So far, it seems to be mostly good. A sick economy can regain its balance, competitiveness and exports increase, and everyone benefits overall. In reality, however, not all the consequences are positive. The example of the Greek economy during the economic crisis is a good illustration of this.
At the height of the Greek financial crisis, many economists saw the return of the drachma as a salvation, and thus the possibility of a cheaper domestic currency. This would primarily help tourism and foreign investors to help Greece get back on its feet. The result: a gigantic economic program in the form of a weak currency.
But there is a problem: the Greek economy offers few industrial goods that are in demand on the world market, and therefore has a structural export problem. Accordingly, Deval cannot be effective, since there are no more exporters who could benefit from it. At the same time, wealthy people lose the incentive to save money as a result. Then investments are made in gold, real estate, FX. As a result, the country lacks money, and the economy slows down.
One of the biggest problems caused by devaluation in the event of an exit from the euro was the huge mountain of Greek debt that would continue to accumulate. Debt reduction would be difficult to achieve in the foreseeable future with a greatly depreciated drachma, and would paralyze the Greek economy for decades. Nevertheless, central banks continue to make efforts to devaluation. This is due, in part, to the aim of reducing deflation in the economy. Efforts are being made to keep inflation at around 2% per year.
The European Central Bank has achieved this more or less successfully through key interest rate adjustments and quantitative easing in the EU in 2019. However, the key interest rate has reached its lowest level at 0%. Other countries, such as the US and Sweden, show that a negative interest rate is not unlikely in the European Union in the future.
How to profit from devaluation
For example, forex traders can make profits from the value of currencies, but they can also suffer losses when the value of the currency fluctuates.
Let's say a trader opens a short position on the EUR/USD pair because he expects the EUR to depreciate against the USD. If the EUR does depreciate, the short position will make a profit. However, if the EUR strengthens, the trader will suffer a loss on his short position.
A trader opens a long position if he assumes that the euro will lose value against the dollar. If the euro appreciates, that is, increases in price, the position can be closed with a profit. However, if the assumption was correct, the long position will suffer losses because it will have to be closed at a worse exchange rate.
How to protect your assets from devaluation
Protecting assets from Deval requires a strategic approach and understanding of financial instruments. Here are some tips:
1. Invest in hard currency
Buying dollars, euros, or other stable FX can reduce the risk of losing the purchasing power of your savings. Keep them in banks, in foreign currency deposits.
2. Diversify assets
Distribute your savings between different tools:
- Currency.
- Real estate.
- Shares or bonds of international companies.
Diversification reduces the risk of losing funds due to fluctuations in one asset category.
3. Invest in gold or other precious metals
Gold is often seen as a safe haven during times of economic uncertainty. Investing in gold or platinum helps preserve capital.
4. Consider investing in real estate
Real estate is one of the most resilient assets, especially in stable regions. Its value often increases or remains stable even during economic crises.
5. Invest in international markets
Open accounts with international brokers to invest in stocks or ETFs of stable companies or economies.
6. Maintain liquidity
Keep some of your assets in an easily accessible form (cash, bank deposit). This will allow you to quickly respond to changes in the economic situation.
7. Choose a foreign currency deposit/account
Open an FX-linked bank account. This tool can protect your funds from a currency collapse.
8. Investing in cryptocurrencies
In times of devaluation, many investors consider cryptocurrencies as an alternative to traditional currencies. For example, Bitcoin is often seen as a hedge against devaluation of national currencies, as its value is largely independent of central bank actions.
9. Follow economic news
Up-to-date information will help you anticipate possible risks and adjust your financial strategy in a timely manner.
Remember: each method has its own risks. Consulting with a financial expert will help you choose the best approach for you.
Conclusion
In general, it can be seen that devaluation has different causes, objectives and consequences. It is unclear whether it is an effective tool or a dangerous balancing act. On the one hand, there are advantages for the domestic and external economy, including increased exports, competitiveness and a balanced current account. On the other hand, there are disadvantages for domestic and external economic activity. The example of the Greek crisis, in particular, illustrates the dangers of ill-considered devaluation of the national currency as an economic tool.
