Why Do Governments Devalue Their Currency Rates?

When a currency is devalued its currency rate against the other major currencies will drop to encourage exports and improve the country trade deficit.

The value of a currency is determined relative to the value of the other currencies i.e. how much of the other currency can be bought by one unit of your home currency. In general, this is the exchange rate of this currency pair and it fluctuates over time with currencies gaining or losing value against each other. When a currency reduces its value against other currencies, this process is called devaluation.

Devaluation is a natural process in the history of financial markets. All currencies witness their currency rates falling and rising and if 10 British pounds were able to buy, say, 20 U.S. dollars a year ago, today the pound could be devalued and its purchasing power would only be enough to buy only 15 dollars. In contrast to market devaluation, governments around the world sometimes resort to devaluation as a tool to protect their trade balances. Thus, the local currency is forcedly devalued and its currency rates against other major currencies is reduced while restrictions are often imposed preventing the home currency from being exchanged at higher rates.

These types of government intervention in the foreign exchange market are a perfect example of official devaluation while the natural market devaluation is often referred to as depreciation, a process when the currency rates fluctuate downwards. In both cases, the country whose currency is devaluated could benefit form the lower cost of its export of goods, which now are cheaper to buy by customers in countries whose currencies are stronger. The history of trade recalls many examples of intentional devaluation with the purpose of conquering new markets through the lower currency rates of the devalued currency.

One of the biggest devaluation waves in history was in the 1930s when at least nine of the leading world economies devalued their national currencies, including Australia, France, Italy, Japan and the United States. During the Great Depression, all these nations decided to abandon the gold standard and to devalue their currencies by up to 40%, which helped revive their economies and stabilised currency rates.

Meanwhile, Germany, which lost the Great War a decade earlier, was burdened to pay strenuous war reparations and intentionally provoked a process of hyperinflation in the country. Thus, the Germans witnessed the biggest ever devaluation of their national currency and the currency rates hit rock bottom. At that time, the currency rate of the German mark to the U.S. dollar stood at several million or billion marks per dollar. On the other hand, this devaluation helped the German government in covering its debts to the war winners although the average Germans paid a disastrous price for this government policy.

The governments around the world are often tempted to lower unnaturally the currency rates in order to benefit from the lower value of the national currency. The lower currency value encourages exports and discourages imports improving the country’s trade deficit and imbalances. However, the average citizen of a country with a recently devalued currency could suffer from higher prices of imported goods and overseas holiday costs.