An authority in a particular country decreases the value of its local currency in order to restore the trade balance (Exports – Imports), or in other words, balance the trade deficit. The monetary procedure known as currency devaluation is conducted when global variations influence the financial behavior patterns and market dynamics (i.e. economic crisis, rise in production costs, pandemics and wars). Thus, a country reduces the value of its own currency against the currency of another country that shares with it its wealth in the central bank (EGP against the USD in Egypt’s case).
Negative Implications of devaluation:
- Foreign products will cost more money.
- Purchasing power of consumers declines (i.e. inflation)
- Salaries and savings will be devalued as well.
Positive Implications of devaluation:
- Boosting of exports because they will become cheaper for foreign merchants after devaluation.
- Encourages national production of good quality and minimize dependence on imported commodities that will be further expensive.
- Fosters foreign investments that will make use of a low-valued market to establish potentially profitable business models with lower costs.
- Encourages investment in the local stock market, including mutual funds and IPOs (Initial public offerings).
- Remittances signify more cash coming from countries with stronger currencies.
- In Egypt, the exchange rate after devaluation attracts more tourists, which will support the tourism sector in accordance.
Here comes a vital question…
Why does the CBE use the USD as the major determinant of its currency’s value (i.e. official reserve currency)?
OR
Why is the USD the most influential currency in the world (the most hegemonic currency)?
1. According to the Congressional research service, since World War II, the dollar has served as the world’s dominant medium of exchange. The majority of central banks now hold roughly 60% of their reserves of foreign currency in dollars (almost 1.8 trillion dollars in circulation worldwide).
2. During major economic downturns, investors prefer the dollar as a “safe haven” currency. To provide liquidity and dollars in such cases, the United States Federal Reserve used exceptional monetary authorities and currency exchange lines with other central banks.
So…
How could individuals and corporates possibly profit from currency devaluation?
- Invest in real estate as a fixed asset, where its value will boom in domestic terms when the currency is devalued. Rent would be a useful commercial strategy.
- Invest in emerging stock markets, such as Egypt, Brazil and Turkey. Traders believe that capital invested in these financial systems will yield returns on the long term.
- Exchanging currencies is a simplistic method of dealing with currency devaluation for individuals, but it can deliver future outputs.
