Money used to be minted from precious metals like gold, silver and bronze, but as those became scarce, money had to be made of other materials such as copper, aluminium, tin, paper and other cheaper ones. As such, it derived its value from the wealth of the country that issued it. This led to a race between countries who tried to improve their position in international markets and to attract investment. This was known as competitive devaluation.
In its most basic form, currency devaluation is a deliberate reduction in the value of a nation’s native currency. This can be achieved by altering interest rates, adjusting reserve requirements and even directly intervening in the foreign exchange market. It’s a strategy commonly employed by central banks to tackle inflationary pressures and boost export competitiveness.
However, it’s a very complex process and one that can have severe implications on a nation’s economy. Some governments will also use it to gain a trade advantage with other countries and as a way of correcting balance of payments imbalances.
By reducing the value of a nation’s indigenous currency, devaluation makes domestic goods less expensive on the global market and foreign goods more affordable for home consumers. This should theoretically lead to a positive balance of trade (exports minus imports). In addition, it can attract tourists and increase the amount of money that residents send abroad in remittances. However, it’s important to note that the state of the global economy plays an influential role in the effectiveness of devaluation as a policy tool.