Whenever one hears of the recent devaluation of a currency, their mind instantly starts painting a picture, strokes start to form that a weak currency is a sign of failure, and oftentimes, they do correlate with one another.
Oftentimes, devaluing currency refers to the official decrease in value of one country’s currency, a decision made by either the Central Bank or government, in a fixed-rate exchange system. Say that you were a maiden or young boy in Ancient Greece, since this practice of devaluation predates Ancient Times, back when coins were made out of precious metals such as gold or silver, the Greeks decided to reduce the weight or maybe the purity of the coins, which caused them to be devalued. Such changes often happened without public announcements or royal decrees, but were nonetheless no less tangible. If you were living in Europe around the time of the Napoleonic Wars, you would notice many nations massively devaluing their currencies to finance wars by reducing the value of coins, as mentioned earlier, either through reducing their weight or purity, as it was before any proper system was established. But why would countries do this? Purposefully making your currency stand and look weak, isn’t that terrible? Such thoughts might be running through your head, and for this, we need to take a trip back to history yet again.
During the 1930’s infamous Great Depression, a time of economic uncertainty and downturn, many nations abandoned the gold standard. The gold standard, simply put, is a monetary system where a nation’s currency is directly linked to a fixed quantity of gold, and the currency is available to convert to gold at that rate. To back this up, either the government or the Central Bank must hold a reserve of gold. The countries that abandoned the gold standard, like the US or France, instead began participating in “devaluation wars” or “currency wars,” where, in an effort to attract more exports, they competitively devalued their currency. Why, though? Why would it attract more exports? The same question could be applied to why China set its currency, the yuan, to a fixed lower rate. Why? To make exports cheaper. When a currency’s strength is weak, it in turn makes imports more costly and its exports cheaper. Through competitively devaluing their currencies, they not only discouraged foreign spending by making their imports more expensive, but they also made their exports cheaper as well. This series of competitive devaluations follows what is the “beggar-thy-neighbor” policy, which refers to when countries try to improve their own situation (economically) at the expense of others (their trading partners). This currency war started with the British massively devaluing the Pound Sterling in 1931, causing many others, like the US or France, as aforementioned, to follow, as well as many other countries in the Commonwealth. As the name “beggar-thy-neighbor” policy suggests, this had negative effects, as many countries simultaneously devalued, leading to any competitive advantage that any other country gained to be quickly lost as others followed suit. Due to this, it exacerbated the economic downturn in the 1930s, which led to them committing this; global trade flows were estimated to drop by around 30% or 25%.
While the currency wars did help end the interwar gold standard system by destroying monetary cooperation and furthering trade frictions, they can serve as a great example of what can occur if you devalue your currency, presenting both the risks and benefits that come with it simultaneously.
