Currency devaluation or lowering the value of a country’s currency is the market intervention that has been in practices for years. Currency devaluation refers to the action taken by a country to deliberately lower the value of its currency relative to other dominant currencies in the market. It is a monetary policy tool that was initially being used by countries that had fixed or semi-fixed exchange rate policy. Many countries have used this policy to recover from financial crisis or economic stability. Others like China have used currency devaluation with the aim of spurring economic growth. However, there is still a controversial debate about the effectiveness of currency market intervention in achieving its objectives ( Eiteman, Stonehill & Moffett, 2012) .
There are three main reasons why countries use currency market interventions such devaluation. First, currency devaluation is used to boost exports. Due to increased globalization, there is stiff competition of goods from various countries in the global market. Therefore, in order to encourage export and discourage export, some countries resort to currency devaluation. Currency devaluation makes exported goods relatively cheaper and imported goods expensive ( Eiteman, Stonehill & Moffett, 2012) . By encouraging export, a country is likely to promote its economic growth. Secondly, currency devaluation is used to reduce trade deficits. An increase in exports and a decrease in imports lead to a favorable balance of payment, causing shrinkage in trade deficits ( Eiteman, Stonehill & Moffett, 2012) . Finally, countries use devaluation to lower sovereign debt burden. A government that has a lot of sovereign burden may be encouraged to lower the value of its currency. Therefore, currency market interventions are mainly economic tools that are aimed at promoting economic growth or restoring economic stability.
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There are instances where currency market interventions have been used successfully to achieve the intended objective. For instance, Sweden used currency devaluation to recover from its early 1990s banking crisis. The devaluations created export boom that restored Sweden economy. Britain also managed to recover from its 1990s doldrums after lowering the value of its currency. However, with high level of globalization, the effectiveness of currency market intervention is in doubt (Ma, 2017).
China is currently one of the countries that rely on currency market interventions, which has affected its relationship with USA. US dollar is the main global currency and by devaluing its renminbi, China is lowering US dollar in the international market. The dollar/ renminbi rate has been increasing since Chinese started devaluation policy (Dollar, 2015). Unfortunately, there is no significant step that the US can use to force China to drop currency market intervention. As a result, to compete with China, its main economic rival in the global market, US has no choice to take measures aimed at encouraging foreign investors and making its products attractive to the global market.
Currency market intervention has helped China to be one of the leading economies in the world. It is estimated to be the second largest economy in the world after USA. China has been able to experience a steady economic growth over the last decade due to its export-led growth is largely attributed to the country’s economic miracle (Scott, 2015). Low values of Chinese currency reduced the price of its exports, making many countries across the globe to buy its products (Ma, 2017). At the same time, a significant increase in its export significantly raised its net export, which led to a substantial GDP growth. In addition, the country has also been seeing a decline in its trade deficits. Therefore, currency devaluation is partly attributed to rapid economic growth that has been witnessed over the last decade.
Chinese trade surplus had reduced from $298 billion to $155 billion between 2008 and 201 (Dollar, 2015). Consequently, the country lowered the value of its local currency to increase the trade surplus. As a result, by 2015, China managed to get its largest surplus, which was about $367 billion compared to 2014 when it was $200 billion. Hence, China largely succeeded in achieving its effort of increasing trade surplus and enhancing its economic growth (Ma, 2017). Chinese products now dominate the global market due to the currency market intervention that significantly reduced the price of its market.
Therefore, generally, I think the Chinese government and the country made a beneficial choice by deciding to lower the value of its local currency. Despite facing some economic challenges, China has experienced rapid growth over the last decade and it is now threatening US’s economic power and dominance globally. Besides, devaluation has enabled China to have a favorable balance of trade. For instance, his balance of trade deficit has dropped from $298.12 billion in 2008 to $156.9 billion in 201, and it has been decreasing since then, making the country to enjoy a steady economic growth (Dollar, 2015). Nevertheless, this intervention has been costly to China. The low value of the local currency has made potential foreign investors to avoid China. Reduced foreign investment meant that China lost opportunity for technological development and employment in the long run. As a result, currency market intervention has both advantages and challenges that should be considers before it is implemented.
References
Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2012). Multinational business finance . Pearson Higher Ed.
Dollar, D. (2015). Currency devaluation and U.S.-China relations. Brookings. Retrieved from https://www.brookings.edu/blog/order-from-chaos/2015/09/21/currency- devaluation-and- u-s -china-relations/
Scott, C. (2015, August 11). Here's why China devalued its currency. Fortune . Retrieved from http://fortune.com/2015/08/11/why-china-devalued-yuan/
Ma, Y. (2017, April 18). The Devaluation of China’s Currency. The Market Mogul . Retrieved from https://themarketmogul.com/devaluation-chinas-currency/
