Currency Devaluation

Currency depreciation refers to a decline in the value of a currency relative to other currencies, requiring more of the domestic currency to be exchanged for an equal value of foreign currency. Currency devaluation will affect a country's economy and society, with both advantages and disadvantages.

Reasons for Currency Devaluation

Trade Deficit

When a country's imports are greater than its exports, it means that the country's external demand is greater than its domestic supply, and more domestic currency needs to be used to purchase foreign goods and services, resulting in an oversupply of the domestic currency and a decline in value.

Capital Outflow

When a country's capital account has a deficit, it means that the country's capital outflows are greater than its inflows, and more domestic currency needs to be exchanged for foreign assets, resulting in an oversupply of domestic currency and a decline in value.

Inflation

When a country's price level continues to rise, it means that the purchasing power of the country's currency has declined, and more domestic currency is needed to maintain the same standard of living, resulting in an oversupply of the domestic currency and a decline in value.

Interest Rate Differential

When a country's interest rate is lower than that of other countries, it means that the country's capital cost is low and less attractive, and it needs to use more of its own currency to exchange for foreign funds, resulting in an oversupply of its own currency and a decline in its value.

Speculative Pressure

When a country's economy or politics is unstable or in crisis, speculators will expect that the country's currency will further depreciate, so they will sell the country's currency in large quantities, resulting in an oversupply of the country's currency and a decline in value.

Impact of Currency Devaluation

• Currency depreciation will make the country's export goods relatively cheap and help improve export competitiveness, but it will also make imported goods relatively expensive and increase import costs.

• Currency depreciation will affect changes in the exchange rate. When a country's currency depreciates, the number of currencies it can exchange into other currencies will decrease. This is reflected in the foreign exchange market as oversupply and reduced demand for the country's currency.

• Currency depreciation will trigger capital outflows. When a country's currency depreciation becomes a sustained trend, domestic and foreign investors will strive to hold foreign currency assets such as US dollars to preserve their value, which will convert a large amount of RMB into foreign currencies, triggering a large number of domestic capital outflows. A "capital account deficit" occurs.

• Currency depreciation will lead to inflationary pressure. As the prices of imported goods rise, it will push up the country's price level and reduce residents' purchasing power. At the same time, due to the increase in exports, it will increase the country's money supply and cause inflation.

How Do Countries Respond to Currency Devaluation?

1. Tightening fiscal policy: by reducing government spending or increasing taxes, reducing government deficits and borrowing needs, reducing the money supply in the market, and increasing the value of the domestic currency.

2. Tightening monetary policy: Reduce the money supply in the market and increase the value of the domestic currency by raising interest rates or reducing the base currency.

3. Capital controls: Reduce the demand for foreign exchange in the market and increase the value of the domestic currency by restricting capital outflows or encouraging capital inflows.

4. Foreign exchange market intervention: reducing the supply of domestic currency in the market and increasing the value of the domestic currency by selling foreign exchange reserves or purchasing domestic currency.

5. Adjust the exchange rate system: By abandoning the fixed exchange rate system or adopting a floating exchange rate system, let market supply and demand determine the exchange rate level and reduce artificial exchange rate imbalances and pressures.

How Do Investors Respond to Currency Depreciation?

1. Carry out hedging transactions and use foreign exchange derivatives such as futures, options, swaps, etc. to lock in future exchange rates and reduce exchange rate risks.

2. Diversify your investments and spread your funds across different currencies and markets to reduce the impact of a single currency depreciation on your overall investment portfolio.

3. Carry out arbitrage trading and take advantage of the exchange rate differences between different markets to buy low and sell high to obtain profits.

4. Carry out reverse trading, predict the direction and extent of currency depreciation, short the currency, and go long another currency to earn profits.