We are re-posting this popular article about the foreign currency and the devaluation and revaluation systems. After all, what's the point of trying to predict foreign exchange markets (FOREX) if you don't even know how the market moves and reacts to change? The world's largest market that is open 24 hours does react to certain changes and you need to know how to watch and interpret these movements. Why let some third-party web application make predictions for you when you can do the work yourself?
Devaluation and Revaluation of Currencies
For all of our examples we will use the comparison between $ (dollar) and € (Euro). To depict what occurs in the economy we will use a model (economists like models). The model employed is called the AA--DD model.
Here is a quick summary of the model. The AA curve represents the asset market and the DD curve represents the output market (goods and services). The X-axis represents production (or GDP (Y)), and the Y-axis depicts the appreciation or depreciation between the domestic currency ($) and foreign currency (€ in this example). For more information on how these models are derived please visit the international economics study web site.
What happens to the domestic economy when currencies are devalued or revalued?
First devaluation:
An announcement to Increase (depreciate) $ with respect to € will lead to the following in domestic markets: Increase of exports (since goods are cheaper), decrease of imports (more expensive to buy); the current account will increase which all leads to increase of Y.
What about the opposite? What happens to the domestic economy when the currency is revaluated?
Quite simply the opposite. An announcement to decrease the exchange rate (appreciate the currency) means decrease in exports, a possibility their will be an increase in imports, and a decrease of the current account. This almost means that Y decreases and C (consumption). You will have a stronger currency at the expense of lower consumption, loss of jobs, etc. This is why China is not in favor of revaluating.
The US on the other hand would like China to revaluate their currency. This would do a few things, namely, decrease the trade deficit for the US. It's also in the interest of China to revaluate as it would slow a heated economy. The idea is if you build to fast then you'll have too much capacity and note enough work to go around (which could deflate the economy when nobody has work). Of course, the flip side to that threat is there's no end in sight for China's growth....
There you have some basic examples of what happens to the economy upon devaluation or revaluation announcements.
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Comments ( 14 )
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why a country needs to use US $ or GBP as a becnmark?? What are the criteria?? could you please explain?
Quite simply it is perceived to be a strong currency that the country can default o in the even of a crisis. Benchmark is also called a 'vehicle currency'.
i know they are the vehicle currency. my question is why they are vehicle currency ?? suppose, Diner has no or almost very little impact compared to a change in US $ . My question is why is that?? is this because of the worldwide investment of US companies or some other effect??
Yes that part is true. Stability of currency is not the only thing to look at. Seeing which economy is strong on the global scale is also a factor. the US for the longest time was a net importer to a WIDE degree. Cozying up to them meant less cost on exchange rates etc. It also meant a degree of stability to peg to another 'stable' economy. Right now the US isn't so stable so you see more movement to other currencies like the Euro.
the kwait diner is more valuable than US $. is this because they have very high level of US dollar reserve due to huge export of oil?? But as their global investment is very low/almost nothing compared to the US therefore no country value their currency against kwait diner , is this correct??
I own an portfolio of european and emerging mkt bonds. If the currencies which hold these bonds goes down in value in relationship to the US Dollar, the value of their interest payment would also go down. BUT if USD is likewise depreciating, the bonds should hedge against the loss of value of the interest payment??
Sounds to me you just loose twice; although, I'm not much of a bond guy so I could be wrong. If both currencies depreciate by the same value you don't loose at all. But if they keep depreciating eventually you loose purchasing power.
The explanations are very clear and understandable. But I could not figure out what is the economic impact of revaluation to the people especially those working abroad. There is something missing that I am looking for. In revaluation, example: If an expatriate income is in riyals that used to be 3.75 against 1 dollar, if it is revalued by 20% what would be the exchange rate against 1 dollar? Is it beneficial or a disadvantage to an expatriate worker?
Technically you should be able to buy more. If you are paid in riyals then your riyals will buy more dollars if the country revaluates. You see, China won't revaluate because their goods will become more expensive and thus exports will decrease slowing the economy.
Are there specific rules outlining the necessary procedures for any currency to revalue.
No since it's up to a country to decide whether they'll revaluate. International pressure may force reavluation, but in reality it's up to the monetary policy of country to make the choice. Generally it's tough for a country that's pegged to revaluate (it appreciates the currency thereby making exports more expensive).
