Advantages of devaluation

1. Exports become cheaper and more competitive to foreign buyers. Therefore, this
provides a boost for domestic demand and could lead to job creation in the export
sector.
2. A higher level of exports should lead to an improvement in the current account
deficit. This is important if the country has a large current account deficit due to a
lack of competitiveness.
3. Higher exports and aggregate demand (AD) can lead to higher rates of economic
growth.
4. Devaluation is a less damaging way to restore competitiveness than ‘internal
devaluation‘. Internal devaluation relies on deflationary policies to reduce prices by
reducing aggregate demand. Devaluation can restore competitiveness without
reducing aggregate demand.
5. With a decision to devalue the currency, the Central Bank can cut interest rates as it
no longer needs to ‘prop up’ the currency with high interest rates.

Disadvantages of devaluation
1. Inflation. Devaluation is likely to cause inflation because:

 Imports will be more expensive (any imported good or raw material will increase in
price)
 Aggregate Demand (AD) increases – causing demand-pull inflation.
 Firms/exporters have less incentive to cut costs because they can rely on the
devaluation to improve competitiveness. The concern is in the long-term devaluation
may lead to lower productivity because of the decline in incentives.

2. Reduces the purchasing power of citizens abroad. e.g. it is more expensive to go

on holiday abroad.

Currency devaluation may lower productivity in the long-term, since imports of

capital equipment and machinery become too expensive for local businesses.
If currency depreciation is not accompanied by genuine structural reforms,
productivity will eventually suffer.
3. Reduced real wages. In a period of low wage growth, a devaluation which causes
rising import prices will make many consumers feel worse off. This was an issue in
the UK during the period 2007-2018.

4. A large and rapid devaluation may scare off international investors. It makes
investors less willing to hold government debt because the devaluation is effectively
reducing the real value of their holdings. In some cases, rapid devaluation can
trigger capital flight.
5. If consumers have debts, e.g. mortgages in foreign currency – after a devaluation,
they will see a sharp rise in the cost of their debt repayments. This occurred in
Hungary when many had taken out a mortgage in foreign currency and after the
devaluation it became very expensive to pay off Euro denominated mortgages.

6 A currency war may lead to greater protectionism and the erecting of trade
barriers, which would impede global trade.
Currency war, also known as competitive devaluations, is a condition in international
affairs where countries seek to gain a trade advantage over other countries by causing
the exchange rate of their currency to fall in relation to other currencies.

united States Currency War

The United States doesn't deliberately force its currency, the dollar, to devalue. But its
use of expansionary fiscal and monetary policy has the same effect.

For example, federal deficit spending increases the debt. That exerts downward
pressure on the dollar by making it less attractive to hold. Between 2008 and 2014, the
Federal Reserve kept the fed funds rate near zero. That increased credit and the money
supply. That also put downward pressure on the dollar.

But the dollar has retained its value despite these expansionary policies. It has a unique
role as the world's reserve currency. Investors buy it during uncertain economic times as
a safe haven. As a result, the dollar strengthened 25 percent between 2014 and 2016.
Since then, it has begun to decline again.

China Currency War

China manages the value of its currency, the yuan. The People's Bank of China
loosely pegged it to the dollar, along with a basket of other currencies. It kept the yuan
within a 2 percent trading range of around 6.25 yuan per dollar. The exchange rate tells
you $1 will purchase 6.25 yuan.

On August 11, 2015, the Bank startled foreign exchange markets by allowing the yuan to
fall to 6.3845 yuan per dollar. On January 6, 2016, it further relaxed its control of the
yuan as part of China's economic reform. The uncertainty over the yuan's future helped
send the Dow down 400 points. By the end of that week, the yuan had fallen to 6.5853.
The Dow dropped more than 1,000 points.

In 2017, the yuan had fallen to a nine-year low. But China wasn't in a currency war with
the United States. Instead, it was trying to compensate for the rising dollar. The yuan,
pegged to the dollar, rose 25 percent when the dollar did between 2014 and 2016.
China's exports were becoming more expensive than those from countries not tied to the
dollar. It had to lower its exchange rate to remain competitive. By the end of the year, as
the dollar fell, China allowed the yuan to rise.

Japan's Currency War

Japan stepped onto the currency battlefield in September 2010. That's when Japan's
government sold holdings of its currency, the yen, for the first time in six years. The
exchange rate value of the yen rose to its highest level since 1995. That threatened the
Japanese economy, which relies heavily on exports.

Japan's yen value had been rising because foreign governments were loading up on the
relatively safe currency. They moved out of the euro in anticipation of further
depreciation from the Greek debt crisis. They left the dollar because they were
concerned about the unsustainable U.S. debt.
Most analysts agreed that the yen would continue rising, despite the government's
program. That's because of forex trading, not supply and demand. It has more influence
on the value of the yen, dollar, or euro than traditional market forces. Japan can flood
the market with yen all it wants. But if forex traders can make a profit from a rising yen,
they will keep bidding it up.

Before the financial crisis, forex traders created the opposite problem when they created
the yen carry trade. They borrowed the yen at a 0 percent interest rate. They invested in
the U.S. dollar which had a higher interest rate. The yen carry trade disappeared when
the Federal Reserve dropped the fed funds rate to zero.

European Union

The European Union entered the currency wars in 2013. It wanted to boost its exports
and fight deflation. The European Central Bank lowered its rate to 0.25 percent on
November 7, 2013. That drove the euro to dollar conversion rate to $1.3366. By 2015,
the euro could only buy $1.05. But that was also partly a result of the Greek debt crisis.
Many investors wondered whether the euro would even survive as a currency. In
2016, the euro weakened as a consequence of Brexit. But when the dollar weakened in
2017, the euro rallied.

HISTORY OF CURRENCY WAR

ou don't have to be an economic historian to know that currency wars are nothing
new. Previous presidents have intentionally depressed the dollar's value to
increase trade, and in fact the idea goes as far back as the Roman Empire.

When the Romans gobbled up Egypt, Judea, Britain and Gaul, the Empire
became stretched, with long supply lines requiring more money to maintain. The
drain on gold and silver meant the Treasury could no longer meet its expenses
with revenues, so Emperor Nero decided the only way to bridge the shortfall was
to print more money (sound familiar?). He did this by reducing the amount of
silver in the coins. This soon caught on with later Emperors, who during the next
two centuries cut the amount of silver in coins from 96% to 0%. The printing of
too many coins led to inflation and a trade deficit with its provinces, as explained
nicely by Stephen Pope in Forbes.

Trump may seems like an outlier economic nationalist with his “Make America
Great Again” slogan and promises to be more protectionist, but previous
presidents have sung the same tune. Examples include all candidates in the
2016 Presidential election criticizing the TPP; Barack Obama and Hillary Clinton
denouncing NAFTA in 2008 – threatening like Trump to renegotiate the treaty;
and Ross Perot back in 1992 with his description of “the great sucking sound” of
jobs disappearing to Mexico.

The first modern-day instances of currency wars occurred in the 1930s when
countries decoupled their currencies from the gold standard. After the Great
Crash of 1929 there was rampant unemployment throughout the developed
world. When Germany devalued its currency in 1931, Britain – then the leading
industrial power – was hard hit by having its foreign exchange reserves drained
by speculators. The Brits thus decided to end the attachment of sterling to gold.
Countries with ties to the British Commonwealth quickly exited the gold standard
as well – leaving currencies to float on their own. The first modern-day instances
of currency wars occurred in the 1930s when countries decoupled their
currencies from the gold standard.

Free from a gold peg, these countries found that devaluing their currencies would
boost their economies, a policy that became known as “beggar thy neighbour”
because they could literally export unemployment to another higher-value
currency country, just as China has done to the US.

Interestingly, Market Realist notes that this “go it your own” system destroyed
any reason for countries to cooperate in financial matters and may have
contributed to the Second World War:

The combination of the U.K split with gold and a U.S devaluation against gold
that occurred in 1933 promoted the intended currency war tactic. Both
economies' competitive devaluations prevented prices from falling, allowed
money supplies to increase and bolstered production. The division between
states created a chasm in cooperation. While this lack of international unity was
not the sole catalyst to the destruction of peace that brought World War II, it was
a part of a growing rivalry that would eventually experience real war. - Market
Realist

The Bretton Woods Agreement of 1944 set up an international economic system

resting on both gold and the US dollar. The signatories included all the major
industrial powers including the US, Japan, Canada, Australia and Western
Europe. The system worked well for about 30 years but in 1973 US President
Nixon took the US off the gold standard. Other countries followed and currencies
were again allowed to float against one another. But the US was clearly the most
powerful currency, especially following an arrangement with Saudi Arabia in the
early 70s to sell Saudi oil in US dollars in exchange for US military protection.

This post-Bretton Woods arrangement worked until 1999 when the European
Union set up a monetary union with a single currency, the euro. This ended
competition between European countries and instead set up a showdown
between the dollar and the euro for currency dominance.

Unexpectedly however, the threat came from Asia, not Europe, in the mid-1990s.
The collapse of Thailand's currency, the baht, in 1997 caused a contagion of
devaluations throughout the region. Members of the ASEAN block were unable to
pay their debts, forcing a bailout from the IMF. But as a condition of the bailouts,
the countries were required to make regular debt repayments and to have a
greater amount of foreign reserves. This created a new demand for the US dollar,
the most powerful currency.
Fast forward to 2008, the financial crisis. With global growth in the tank, a new
currency war was about to break out, with most developed countries seeing
increased exports as the way out of the low growth dilemma. Countries began
lowering interest rates to encourage borrowing and consumer spending, which
also dropped currency valuations.

“In its latest effort to try and stimulate the U.S. economy, the Federal Reserve cut
its key interest rate to a range of between zero percent and 0.25%, and said it
expects to keep rates near that unprecedented low level for some time to come.”
CNNMoney.com, December 16, 2008

Money started flowing to emerging economies out of developed economies,

which offered higher bond yields such as the situation with Brazil described
above.

One exception was Japan, which saw the yen lose about a third of its value
between 2012 and 2014, meaning higher profits for exporters like Toyota.