Essay Preview: Devaluation
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An argument amongst monetarists is whether or not currency devaluations are
productive. Some economists believe devaluation can cause great inflationary pressures. First, I would like to give a brief overview of the concept of devaluing of the dollar. One important note is that all currencies at some point have been devalued at one time or another. When a country imports more than it exports, there will be pressure on that countrys currency to devalue. However, if the trade deficit is offset by inflows of capital( for investment purposes), the country can continue to run the trade deficit without having to devalue. When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currencys fixed exchange rate weak. In order to nourish a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.
There are other policy issues that might guide a country to change its fixed exchange rate. For example, rather than implementing unpopular fiscal spending policies, a government might try to use devaluation to boost aggregate demand in the economy in an effort to fight unemployment.
If observers believe that the government will not be able to defend its currency, they may very well attempt to profit from the devaluation. There is very little risk when trying to profit from a currency devaluing. The most that is likely to be lost is the mere transaction costs. If an observer is right, then there can be a large profit at the end of the rainbow. George Saros profited over $1 billion when Great Britain
devalued in 1992.
If a country that has devalued its currency has borrowed a great deal in a foreign
currency, then the cost of the debt can go through the roof causing companies to enter into bankruptcy or into default. Incidents of this nature can push the economy into a recession, hence pushing down stock prices. Devaluation can also be an opportunity for companies. The devaluing of a currency can permit the countrys government to roll over debt that would currently be due. Governments could also be forced to make structural adjustments in their economies. The International Monetary fund often oversees this restructuring. Devaluations make exports cheaper, and imports more expensive. To that end, many countries use currency devaluations as a means to achieve national economic and social goals(ie: slimming trade deficits, boosting exports,increase of domestic employment).
Some countries with persistent devaluations often end up with large trade deficits
and weak currencies,