Why Would a Country Devalue its Own Currency!?
Devaluing your own currency. Sounds like a bad deal. However, countries can and do devalue its own currency to their advantage - mainly economical, but with the potential for more dire, more global consequences. This article explores why they bother going through the exercise.
Why does it happen?
Typically, currency wars begin when countries experience slow, or even negative domestic growth. Recall that a country's GDP (a general indicator for a country's economic health) is expressed by its consumption, investment, government spending, and net exports (exports minus imports).
A country with a weakening economy will attempt to stimulate all four of the above factors. This includes increasing net exports by increasing exports. More exports is more money coming into the country. The fastest way of achieving this may be to devalue, or cheapen its own currency.
In a probably greatly simplified example, let's say Toyota currently sells its Rav 4 Hybrid to US car dealerships for 1,430,000 yen, or US$14,300 (assume an exchange rate of 100:1). In an attempt to boost exports, let's say the Japanese government (with the support of major Japanese exporters) decide to devalue the yen by, say, 20%.
2020 Toyota Rav 4 Hybrid
While the price of the car stays at 1,430,000 yen, the devaluation of JPY means the USDJPY exchange rate is now 120:1 (it is 20% cheaper to buy yen; aka previously you got 100 yen for every dollar, now you get 120 yen for every dollar). In effect, what originally costs the US car dealership US$14,300 now costs it US$11,916 (1.43m yen divide by 120), ie. what looks and feels very real like a 20% discount.
As the US car dealership is likely able to pass down the reduction in cost in the form of reduction in price to prospective car buyers, this is likely to lead to an increased demand, and subsequently sales, from US buyers. Notice: the revenue to Toyota (in terms of yen) is identical before and after the currency devaluation - at 1,430,000 yen per unit - but it has managed to shore up additional demand, seemingly out of nowhere. Increased sales will help Toyota increase profits, invest more heavily in R&D, hire workers, and continue to stay in business. This, in turn, shores up the Japan economy.
A Double Whammy - the Other Side
What's more - devaluing yen vs. dollar also makes local products more competitive vs. US products. Just as a yen dollar devaluation makes Toyota products become 'cheaper' in the eyes of US consumers; US imports (eg. a Tesla Cybertruck) also become more expensive to Japanese consumers. Let's say a Cybertruck was US$50,000 prior to the yen devaluation. It stays the same price domestically in US, at US$50,000.
In terms of yen, the price suddenly jumps from 500,000 yen to 600,000 yen - what looks and feels very much like a price increase to Japanese buyers. Therefore, devaluing a currency has the potential dual impact of increasing exports AND decreasing imports (both helping to increase net exports - recall GDP formula).
Conclusion
Currency devaluation can be a tempting quick fix for a declining economy (especially countries that have a large export sector), as it has the potential to drive growth quickly.
However, as you can imagine, events do not occur in a vacuum and there are consequences to such actions. We'll explore the impact of such currency devaluations (some would call it 'currency manipulation') in the next article.
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