What is a Weak Currency
A weak currency refers to the legal tender of a nation that has seen its value decrease in comparison to other currencies. Weak currencies are often thought to be those of nations with poor economic fundamentals or systems of governance. In practice, currencies weaken and strengthen against each other for a variety of reasons, although economic fundamentals do play a primary role.
Understanding Weak Currency
Fundamentally weak currencies often share some common traits. This can include a high rate of inflation, chronic current account and budget deficits, and sluggish economic growth. Nations with weak currencies may also have much higher levels of imports compared to their exports, resulting in more supply than demand for such currencies on international foreign exchange markets — if they are freely traded. While a temporary weak phase in a major currency provides a pricing advantage to its exporters, this advantage can be wiped out by other systematic issues.
- There can be many contributing factors to a weak currency, but a nation's economic fundamentals are usually the primary one.
- Export dependent nations may actively encourage a weak currency.
- Currency weakness (or strength) can be self correcting in some cases.
Examples of Weak Currencies
Currencies can also be weakened by domestic and international interventions. For example, China intervened to weaken its currency in 2015 after a long period of strengthening. Moreover, the imposition of sanctions can have an immediate affect on a country's currency. As recently as 2018, sanctions weakened the Russian ruble, but the real hit was in 2014 when oil prices collapsed and the annexation of Crimea set other nations on edge when dealing with Russia in business and politics.
Perhaps the most interesting recent example is the fate of the British Pound as Brexit nears. The UK was a stable currency, but the vote to leave the European Union set the pound on a very volatile path that has seen it weaken in general as the process of leaving has plodded along.
Supply and Demand Rule Weak Currencies
Like every asset, currency is ruled by supply and demand. When the demand for something goes up, so does the price. If most people convert their currencies into yen, the price of yen goes up, and yen becomes a strong currency. Because more dollars are needed to buy the same amount of yen, the dollar becomes a weak currency.
Currency is, after all, a type of commodity. For example, when a person exchanges dollars for yen, he is selling his dollars and buying yen. Because a currency’s value often fluctuates, a weak currency means more or fewer items may be bought at any given time. When an investor needs $100 for purchasing a gold coin one day and $110 for purchasing the same coin the next day, the dollar is a weakening currency.
Pros and Cons of a Weak Currency
A weak currency may help a country’s exports gain market share when its goods are less expensive compared to goods priced in stronger currencies. The increase in sales may boost economic growth and jobs, while increasing profits for companies conducting business in foreign markets. For example, when purchasing American-made items becomes less expensive than buying from other countries, American exports tend to increase. In contrast, when the value of a dollar strengthens against other currencies, exporters face greater challenges selling American-made products overseas.
Currency strength or weakness can be self-correcting. Because more of a weak currency is needed when buying the same amount of goods priced in a stronger currency, inflation will climb as nations import goods from countries with stronger currencies. Eventually the currency discount may spur more exports and improve the domestic economy provided that there are not systematic issues weakening the currency.
In contrast, low economic growth may result in deflation and become a bigger risk for some countries. When consumers begin expecting regular price declines, they may postpone spending and businesses may delay investing. A self-perpetuating cycle of slowing economic activity begins and that will eventually impact the economic fundamentals supporting the stronger currency.