In the modern world, most currencies represent fiat money not backed by any commodity or precious metal and whose value is derived from government regulation. While certain countries maintain an economic policy of fixed exchange rates by pegging the value of their currencies to the value of another currency, most countries have a floating exchange rate policy that allows currencies to either depreciate or appreciate as their demand and supply change. The key benefits of the currency devaluation are smaller trade deficits, boosts to employment and a slowdown in the growth of the country's net indebtedness. Certain countries sometimes engage in the Beggar-Thy-Neighbor policy with competitive devaluation to achieve the above-mentioned benefits.

Currency Depreciation Reasons

Currencies most commonly depreciate due to speculative reasons, economic and monetary policies of the country, and the country's expected growth potential. If the country conducts expansionary monetary policy and does not restrict international capital mobility, its currency tends to devalue with time. Also, if the country is likely to experience economic stagnation or recession in the future, investors usually pull money out of the country, causing its exchange rate to drop. Finally, currency can depreciate as a result of a speculative attack.

Smaller Trade Deficit

When the currency depreciates, the primary beneficiaries of such an event are exporting industries. The exchange rate sets the price of domestic goods relative to that of foreign goods. If the currency depreciates, the exports become cheaper and more competitive on the international markets, boosting trade balance and narrowing trade deficit for the country.

Employment Boost

Increased employment is also another byproduct of currency depreciation, and it comes as a result of the increase in domestic production for exports and local consumption. Keeping all other things constant, as the exporting industries increase their activities, they hire more labor domestically to produce more products and services for international markets. This creates a boost to employment and better income opportunities for workers.

Currency depreciation makes foreign goods more expensive compared to domestic goods, leading to increased demand for domestic products and services. This also contributes to the increase in domestic economic activity and boosts employment.

Slowed Net Indebtedness Growth

If the country has a large trade deficit as a result of imports exceeding exports, it finances its trade imbalance by borrowing from the rest of the world. As the trade deficit narrows or turns into a trade surplus, the country does not have to borrow as much and the growth in net indebtedness may slow down. However, this benefit may be completely counterbalanced by a rise in the cost of servicing debt, if it is denominated in the foreign currency.

Beggar-Thy-Neighbor Policy

Certain countries engage in the Beggar-Thy-Neighbor policy, where the country establishes import barriers and conducts its monetary policy to produce currency devaluation with an intent to gain the above-mentioned benefits. Although such a policy can be beneficial for the country in the short-term, it may result in a trade war or currency war with the country's trading partners.

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