But suddenly, that endless flow of money reversed. Their junk-rated overleveraged portfolio companies issue new loans, but instead of using the funds for expansion projects or other productive uses, they hand them out through the back door as special dividends.
However, the volatility and risks involved may not make it worth it this time, as China has made recent efforts to stabilize and globalize the Yuan.
The ironic thing is that for many years, the United States government had been pressuring the Chinese to devalue the Yuan, arguing that it gave them an unfair advantage in international trade and kept their prices for capital and labor artificially low. Ever since world currencies abandoned the gold standard and allowed their exchange rates to float freely against each other, there have been many currency devaluation events that have hurt not only the citizens of the country involved but have also rippled across the globe.
If the fallout can be so widespread, why do countries devalue their currency? To Boost Exports On a world market, goods from one country must compete with those from all other countries.
Car makers in America must compete with car makers in Europe and Japan. If the value of the euro decreases against the dollar, the price of the cars sold by European manufacturers in America, in dollars, will be effectively less expensive than they were before.
Interesting Facts About Imports and Exports. In other words, exporters become more competitive in a global market. Exports are encouraged while imports are discouraged. There should be some caution, however, for two reasons.
The second is that as other countries see this effect at work, they will be incentivized to devalue their own currencies in kind in a so-called "race to the bottom. To Shrink Trade Deficits Exports will increase and imports will decrease due to exports becoming cheaper and imports more expensive.
This favors an improved balance of payments as exports increase and imports decrease, shrinking trade deficits. Persistent deficits are not uncommon today, with the United States and many other nations running persistent imbalances year after year.
Economic theory, however, states that ongoing deficits are unsustainable in the long run and can lead to dangerous levels of debt which can cripple an economy.
Devaluing the home currency can help correct balance of payments and reduce these deficits. Government Investment Or Irresponsibility? There is a potential downside to this rationale, however.
Devaluation also increases the debt burden of foreign-denominated loans when priced in the home currency. These foreign debts become more difficult to service, reducing confidence among the people in their domestic currency.
To Reduce Sovereign Debt Burdens A government may be incentivized to encourage a weak currency policy if it has a lot of government-issued sovereign debt to service on a regular basis.
If debt payments are fixeda weaker currency makes these payments effectively less expensive over time. Again, this tactic should be used with caution. As most countries around the globe have some debt outstanding in one form or another, a race to the bottom currency war could be initiated.
The Bottom Line Currency devaluations can be used by countries to achieve economic policy.
Having a weaker currency relative to the rest of the world can help boost exports, shrink trade deficits and reduce the cost of interest payments on its outstanding government debts.
There are, however, some negative effects of devaluations. They create uncertainty in global markets that can cause asset markets to fall or spur recessions. Countries might be tempted to enter a tit for tat currency war, devaluing their own currency back and forth in a race to the bottom. This can be a very dangerous and vicious cycle leading to much more harm than good.US presidents have long declined to comment on the value of the dollar or other currencies, instead emphasising confidence in the US currency’s strength.
The huge international US military presence, swollen by the Vietnam war, added to the pressures on the US payments position, forcing Washington in to suspend conversion of the dollar into gold.
Those were the first tremors. With a potential outbreak of a trade war between China and the US, talks of the Chinese using currency devaluation as a strategy have been rumbling. However, the volatility and risks involved may. 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.
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