Why and How Countries Devalue Their Own Currencies

Countries have to devalue their own currencies to encourage exports.

Bitcoin exists to protect us against the theft of inflation. We assume that countries do not have a desire to debase our savings. We assume that the central banks of our country will try to increase the value of our currency, not decrease it. But sometimes, countries are forced to devalue their currencies to encourage exports. We will understand why and how in this article.

To understand how and why countries devalue their currencies to encourage exports let's do a thought experiment.

Assume that there are two countries: Country A and Country B and each have 10,000 people.

Each person has $1 with them.

The currency of country A is A$ and the currency of country B is B$.

The total money circulation in country A is 10,000 A$ and in country B it is 10,000 B$. 1 A$ is equal to 1B$.

No change is needed as long as the countries keep it to themselves and don’t import or export stuff. However, if these two countries start trading with each other, then we have a potential problem.

If Country B exports $1000 worth of goods to Country A, then Country A pays Country B with A$, not B$. Because all they have is A$.

Exporters in Country B cannot use A$ for internal spending, so the central bank converts the currency into B$ at an exchange rate.

If Country B wants to buy $1000 worth of goods from Country A, they pay Country A with the A$ they have already accumulated in the forex reserves. If the trade balance is equal then 1 A$ = 1 B$. The exchange rate is just 1:1.

In the real world, one country will have something of more value and will have a higher power geopolitically. A country with higher power can reject certain types of currencies.

For example, if we want to buy something from the US, they might not accept our local currency in return for goods and services. However, they pay us in US Dollars and we gladly accept it. We accept it because we can buy something from them again and other countries also accept the US dollar.

In this example, let’s assume that Country A has a higher power because it produces Oil and it is more in demand than what Country B exports to Country A.

Now if Country B wants to buy $2000 worth of Oil Barrels from Country A, they can’t because they have only $1000 in their forex reserves (from the previous exports to Country A). Either Country A needs to accept B$ in exchange for Oil or Country B needs to make more A$ for themselves to buy Oil from Country A. If both these options fail, then Country B can go into debt but that would be the last option.

Country B is now at the receiving end. They need to somehow get more A$ so that they can continue their Oil imports.

What Country B exports to Country A might not be that valuable. The only way they can export is to make it cheap for Country A to buy from Country B.

Country B can inflate their currency supply from 10,000 B$ to 20,000 B$ and that would make the exchange rate of A$ = 2B$.

Or 1B$ = 0.5A$. That makes it cheap for Country A to buy from Country B. Then Country B can export more to Country A.

Country B doesn’t care that inflation will happen within their country and make the cost of living high for people. That’s not what they worry about. They worry about having enough forex reserves. So through financial manipulation, they can do this. China has the highest amount of US dollar reserves but that doesn’t mean that the factory workers in China are earning a good living.

When the local currency inflates supply and makes it cheaper for other countries to buy goods and services from that country, the effect of inflation is not immediately apparent in the country that has devalued its currency.

If you are getting paid more than what you have been getting, you will be happy. But your cost of living will increase slowly. If a frog comes in contact with boiling water, it will jump off. However, if you put a frog in warm water and slowly increase the temperature, it will not know when to jump and will die there.

The people working for them haven't yet realized that prices are going to go up due to inflation, but it happens slowly. For the time being, they are happy to get paid more B$ even though it has lower purchasing power.

This devaluation will make sure that country B is exporting and through exports they get A$ in their foreign currency reserve.

Country B's higher powers have successfully tricked the people in Country B to work for cheaper wages. People in country B will eventually feel that the cost of everything has doubled because the total money in circulation was 10,000 units of B$ but now it is 20,000 units of B$.

No one intended these people to suffer, but people lost their savings because the currency was inflated, to encourage exports and let the country have foreign currency reserves of the country where they are importing stuff from.

China has $3.2 Trillion of US dollar reserves because they successfully exported so much to the US and the world. But it came at the cost of making some people in China very rich and most people very poor. You might have to re-read this to let it sink in. Economics is not easy to understand in the first attempt.

The people in country B will also be encouraged to do an export business because they make more in B$ terms. After all, the central bank of country B keeps the A$ in the foreign currency reserves and gives 2 B$ to the business owner who is exporting stuff.

If you export $1,000 worth of services, you don't get paid in US dollars. You get paid in your local currency which is converted at the currency exchange rate. Who keeps the dollars? The central bank.

If the businesses in country B choose to serve the local population, might not earn that much because now the B$ is devalued and people have lesser savings with them.

And the imports from country A are going to be costly which makes the cost of living in the country higher. This also makes the rich richer (the people who export) and the poor poorer.

The local folks in country B whose currency is devalued didn't hedge against this by holding A$ or exporting to country A which led to high B$ earnings.

Having the same fixed supply currency in all the countries and not having different currencies with different supply and circulation levels will reflect the true price of everything.

People who earn and save in that currency will be protected from inflation and the debasement of their purchasing power. That currency, hopefully, will be Bitcoin.