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What is 'Devaluation'

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

!--break--Devaluing a currency is decided by the government issuing the currency, and unlike depreciation, is not the result of non-governmental activities. One reason a country may devaluate its currency is to combat trade imbalances. Devaluation causes a country's exports to become less expensive, making them more competitive in the global market. This, in turn, means that imports are more expensive, making domestic consumers less likely to purchase them, further strengthening domestic businesses.

While devaluating a currency can seem like an attractive option, it can have negative consequences. By making imports more expensive, for example, it protects domestic industries who may then become less efficient without the pressure of competition. Higher exports relative to imports can also increase aggregate demand, which can lead to inflation.

Examples of Devaluation

The devaluation of currencies arises in many situations, but comes about due to specific government action. For example, Egypt has faced constant pressure from a black market for U.S. dollars (USD). The rise of the black market came about due to a foreign currency shortage that hurt domestic businesses and discouraged investments within the economy. To stop the black market activity, the central bank devalued the Egyptian pound in March 2106 by 14% when compared to the USD.

The Egyptian stock market responded favorably when the currency was devalued. However, the black market responded by depreciating the exchange rate of USD to the Egyptian pound, forcing the central bank to take further action. As of July 12, 2016, it's expected that the central bank will devalue its currency again. The stock market reacted favorably to the news, rallying on July 12, and subsequently declining slightly on July 13 when bankers said that no devaluation would occur for the week.

Using another example, China has been accused of practicing a quiet devaluation of its currency in 2016 to prepare for the results of the presidential elections in November 2016. This is due to the fact that both candidates, Hillary Clinton and Donald Trump, have spoken out against China. It would do well for the country to strengthen the Yuan versus the USD to repair economic relationships with the United States. Some believe that the country is secretly devaluing its currency so that it can revalue it after the November election, making it look like it is cooperating.

BREAKING DOWN 'Devaluation'