FED Explanation of a Revalue and Devalue

[DinarChiTown]

http://www.newyorkfed.org/aboutthefed/fedpoint/fed38.html

Currency Devaluation and Revaluation

Under a fixed exchange rate system, devaluation and revaluation are official changes in the value of a country's currency relative to other currencies. Under a floating exchange rate system, market forces generate changes in the value of the currency, known as currency depreciation or appreciation.

In a fixed exchange rate system, both devaluation and revaluation can be conducted by policymakers, usually motivated by market pressures.

The charter of the International Monetary Fund (IMF) directs policymakers to avoid "manipulating exchange rates...to gain an unfair competitive advantage over other members."

At the Bretton Woods Conference in July 1944, international leaders sought to insure a stable post-war international economic environment by creating a fixed exchange rate system. The United States played a leading role in the new arrangement, with the value of other currencies fixed in relation to the dollar and the value of the dollar fixed in terms of gold—$35 an ounce. Following the Bretton Woods agreement, the United States authorities took actions to hold down the growth of foreign central bank dollar reserves to reduce the pressure for conversion of official dollar holdings into gold.

During the mid- to late-1960s, the United States experienced a period of rising inflation. Because currencies could not fluctuate to reflect the shift in relative macroeconomic conditions between the United States and other nations, the system of fixed exchange rates came under pressure.

In 1973, the United States officially ended its adherence to the gold standard. Many other industrialized nations also switched from a system of fixed exchange rates to a system of floating rates. Since 1973, exchange rates for most industrialized countries have floated, or fluctuated, according to the supply of and demand for different currencies in international markets. An increase in the value of a currency is known as appreciation, and a decrease as depreciation. Some countries and some groups of countries, however, continue to use fixed exchange rates to help to achieve economic goals, such as price stability.

Under a fixed exchange rate system, only a decision by a country's government or monetary authority can alter the official value of the currency. Governments do, occasionally, take such measures, often in response to unusual market pressures. Devaluation, the deliberate downward adjustment in the official exchange rate, reduces the currency's value; in contrast, a revaluation is an upward change in the currency's value.

For example, suppose a government has set 10 units of its currency equal to one dollar. To devalue, it might announce that from now on 20 of its currency units will be equal to one dollar. This would make its currency half as expensive to Americans, and the U.S. dollar twice as expensive in the devaluing country. To revalue, the government might change the rate from 10 units to one dollar to five units to one dollar; this would make the currency twice as expensive to Americans, and the dollar half as costly at home.

Under What Circumstances Might a Country Devalue?

When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency's fixed exchange rate untenable. In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.

A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies. There are two implications of a devaluation. First, devaluation makes the country's exports relatively less expensive for foreigners. Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports. This may help to increase the country's exports and decrease imports, and may therefore help to reduce the current account deficit.

There are other policy issues that might lead a country to change its fixed exchange rate. For example, rather than implementing unpopular fiscal spending policies, a government might try to use devaluation to boost aggregate demand in the economy in an effort to fight unemployment. Revaluation, which makes a currency more expensive, might be undertaken in an effort to reduce a current account surplus, where exports exceed imports, or to attempt to contain inflationary pressures.

Effects of Devaluation

A significant danger is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can aggravate inflation. If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth.

Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be jeopardized. Thus, devaluation may dampen investor confidence in the country's economy and hurt the country's ability to secure foreign investment.

Another possible consequence is a round of successive devaluations. For instance, trading partners may become concerned that a devaluation might negatively affect their own export industries. Neighboring countries might devalue their own currencies to offset the effects of their trading partner's devaluation. Such "beggar thy neighbor" policies tend to exacerbate economic difficulties by creating instability in broader financial markets.

Since the 1930s, various international organizations such as the International Monetary Fund (IMF) have been established to help nations coordinate their trade and foreign exchange policies and thereby avoid successive rounds of devaluation and retaliation. The 1976 revision of Article IV of the IMF charter encourages policymakers to avoid "manipulating exchange rates...to gain an unfair competitive advantage over other members." With this revision, the IMF also set forth each member nation's right to freely choose an exchange rate system.

[Darin]

Well, I bet as of now exports exceed imports w/ their oil.

And oil being 90% of the govt income.

Only problem is... the crude is sold via petrodollar.

Wonder if that is any sort of impact.

[Dr. Bobby]

Wow thats a lot of words, a little long so I didn't read it all but who cares cause I gave you an A+

[chilli24]

Wow thats a lot of words, a little long so I didn't read it all but who cares cause I gave you an A+

A little A.D.D. problem Bobby? LOL jk.

[Dumped On Joe]

So the end result being ... If you have a low valued currency it takes massive amounts of money to get anything and when you sell something you don't get much because their currency is more valuable than yours???

Is this why a country can be like China where their GDP is very high and their people remain in poverty?

Guess the other kicker is when you have to exchange and the banks charge exorbitant rates.

So balanced currency does become an issue,,, unless you are selling your oil for US Dollars then converting so the only ones getting any money are the wealthy and government???

Talk about financial oppression!!

GO RV!! For Iraqi people as much as for us!!

[DinarChiTown]

I find this particular paragraph of most interest.

"In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves."

Can someone smarter than I please explain this.

Thanks

[yusofsabri]

Thanks for great post.

[jg1]

So the end result being ... If you have a low valued currency it takes massive amounts of money to get anything and when you sell something you don't get much because their currency is more valuable than yours???

Is this why a country can be like China where their GDP is very high and their people remain in poverty?

Guess the other kicker is when you have to exchange and the banks charge exorbitant rates.

So balanced currency does become an issue,,, unless you are selling your oil for US Dollars then converting so the only ones getting any money are the wealthy and government???

Talk about financial oppression!!

GO RV!! For Iraqi people as much as for us!!

I'm thinking that for China, the low value currency helps sell products which helps build the economy, but does not help the china's people because they cant buy commodities to feed their family's. I wonder if Iraq is doing the same thing, keeping their currency low so there will be more foreign investment, more people buying their products but buying imported goods for their family is expensive causing unrest in the country which most country's do not care about anyway, unless their are massive protests and government takeover's. Governments love to see their economy grow, no matter who or what they hurt in the process.

Say like illegal workers in the U.S, they are helping the economy grow, so they don't care how many jobs they take or people are hurt.

I like this part, or to attempt to contain inflationary pressures.

[redbaron]

I find this particular paragraph of most interest.

"In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves."

Can someone smarter than I please explain this.

Thanks

Here is an article that compares managed to fixed or floating exchange rates which may explain it a little easier. GO RV

[Darin]

I find this particular paragraph of most interest.

"In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves."

Can someone smarter than I please explain this.

Thanks

Could be why the CBI has been doing currency auctions for so long.

The rates are posted on the CBI.. The U.S. is not the only one getting IQD.

Iraq probably has plenty of foreign reserves, which I would believe is predominantly USD.

Something to think about... The price of Crude is sold based upon the value of the dollar. As of recent, the dollar has been on a downward decline. What that means to a country like Iraq, is they're not really getting the extra value per barrel. Luckily, crude is near $100 per barrel.. But as unrest eases, it may drop significantly.

[R2d2dc]

Thanks for the post

[hammy]

Take a look at page 5 in this report. It shows import amounts and export expense. So long as oil stays at the price it is at, they (Iraq) will continue to be in the Black. Which is very good for a R.V.

http://www.state.gov/documents/organization/156992.pdf

Edited March 2, 2011 by hammy