The value of a country’s currency is often judged by weighing it against other countries’ currencies. When one country decides to lower the value of its monetary units, this is known as currency devaluation. As a result, stronger currencies are capable of buying more of the weaker currency.
Most people think of money as something which is used to make purchases. Many do not consider that money may also be purchased. There are numerous types of currencies in the world. Each normally has a different value when they are compared.
For example, one US dollar (USD) may equal seven South African rands (ZAR). This means if a person took one USD to South Africa and exchanged it, she would receive seven ZAR. If, however, South Africa decided to devalue its currency, one USD would purchase more ZAR, perhaps ten, because they would be cheaper.
On the contrary, currency devaluation means that the weaker currency will purchase less of more expensive currencies. If the person with seven South African rands wanted to exchange them for US dollars after the currency was devalued, she would not even receive a full dollar. Her seven ZAR would only equal some cents when converted to American currency.
A differentiation should be made between devaluation and depreciation. When a currency depreciates, it also loses value. The difference, however, is that devaluation is an official decision. This means that the lowering is intentional. With depreciation, this may not be the case.
One motive for currency devaluation is the lack of foreign currency reserves. A country generally buys its surplus currency with stronger foreign currencies. When these stronger currencies are in short supply or a country is unwilling to spend its foreign reserves, a dilemma arises. Currency devaluation may be seen as a solution because it will allow the country to use less foreign currency to recover more of its own currency.
There are numerous effects produced by currency devaluation. One that is often seriously considered is the impact on trade. When a country’s currency is devalued, its goods become cheaper to countries with stronger currencies. This can be a positive effect if the goal is to generate revenue.
Currency devaluation can also have a negative effect on trade. Weakening the currency means products in countries with stronger currencies become more expensive. If the country with the weak currency does not curb imports, this means it will need more money to pay for the same amount of foreign goods.