Do other countries devalue their currencies?
Countries devalue their currencies only when they have no other way to correct past economic mistakes – if their mistakes or committed by their predecessors. The evils of the devaluation still at least equal to its advantages. It is true that it is an incentive for exports and discourage imports of some grades and for a limited period of time.
In a previous article this article describes what Governments resort to such drastic measure. In this article it will be how do them it.
A Government can force a devaluation by a trade deficit of doom. Thailand, Mexico, Czech Republic – all devalued strongly, want it or not, after its trade deficit exceeded 8% of GDP. You can decide to devalue as part of a package of economic measures that is likely to include the freezing of wages, costs the Government and rights collected by the Government for the provision of public services. This, in part, has been the case in Macedonia. In extreme cases and when the Government refuses to respond to signals from the market’s economic difficulties – that they can be forced to the devaluation. International and local buying speculators badges by the Government until its reserves are depleted and you have no money or to import basic foodstuffs and other necessities.
Therefore forced, the Government has no choice but to devalue and return to the currency market which has sold cheaply to speculators buy very expensive.
In general, there are two known of exchange rate systems: the floating and fixed the.
In the floating system, the local currency is allowed it to fluctuate freely against other currencies and its exchange rate is determined by the market forces within a local (or international) changes little regulated foreign market. coins do not have to necessarily be fully convertible, but some degree of free convertibility is a sine qua non condition.
In the stationary system, rates are centrally determined (normally by the Central Bank or by the Conversion box, which supplants the role of the Central Bank). The rates are determined periodically (usually daily) and revolve around a “bonding” with very small variations.
Life is more complicated than any economic system, there are no “pure cases”.
Even in the rate flotation systems, central banks intervene to protect their currencies or to move them to an exchange rate considered favorable (to the economy) or “fair”. invisible hand of the market is often handcuffed by ‘We-know-best’ central banks. This usually leads to disastrous (and surprisingly expensive) consequences. Suffice it to mention the pound sterling in 1992 debacle and the $ 1 billion made during the night by arbitrajista-especulador Soros – as a direct result of the wrong policy and hubris.
floating rates are considered a protection against the deterioration of terms of trade.
If exports drop prices or increase in import prices – exchange rate will be adjusted to reflect the new flows of foreign currency. The resulting devaluation will be rebalancing.
floating rates are also good as a protection against the “hot” (speculative) of foreign capital in search of a quick kill and disappear. To buy the currency, speculators will have to pay more expensive, due to an adjustment to the rise in the exchange rate. Conversely, in the case of cash benefits, it will be sanctioned by a new exchange rate.
Thus, the floating rates are ideal for countries with export prices and volatile speculative capital flows. This characterizes the majority of emerging economies (also known as the third world).
It seems surprising that only a very small minority of these States has them until one remembers their high rates of inflation. Nothing like an interest rate fixed (along with the consistent and prudent economic policies) to calm inflationary expectations. Linked rates also help to maintain a steady foreign exchange reserves level, at least while the Government does not depart from the good macroeconomic management. It is impossible to overestimate the importance of stability and predictability that are the result of fixed rates: investors, entrepreneurs and traders can plan in advance, to protect themselves from coverage and concentrate on long-term growth.
It is not that a fixed exchange rate is forever. Coins – in all types of systems for the determination of the type – they move against each other to reflect new realities in economic or expectations with respect to these realities. Only the pace of change in exchange rates is different.
Countries have invented many mechanisms to deal with the fluctuations of exchange rates.
Many countries (Argentina, Bulgaria) have conversion boxes. This mechanism ensures that all local currency in circulation is covered by foreign currency reserves in the coffers of the Central Bank. All Governments, the Central Bank alike–you can’t print money and they must operate within the straitjacket.
Other countries link their currency to a basket of currencies. The composition of this basket is supposed to reflect the composition of the country’s international trade. Unfortunately, rarely does, and when it does, rarely updated (as it is the case in Israel). Most of the countries link their currencies to the arbitrary baskets of currencies in which the dominant currency is a “hard and good reputation” currency like the US dollar.UU… This is the case with the Thai baht.
In Slovakia, the basket is made up of two unique coins (40% in US dollars and 60% DM) and the Slovak koruna is free to move 7% up and down, around the basket-PEG.
Some countries have a “crawling peg”. This is a type of change, one by another, which is fractional currency changes every day. The currency is devalued at a rate established in advance and made known to the public (transparent). A close variant is the “fluctuation band” (used in Israel and in some countries of South America). The exchange rate is allowed to move within a band, above and below a center of bonding which, in itself is depreciated day at a preset rate.
This default rate reflects a real devaluation planned above the rate of inflation.
The country intended is denoted to promote their exports without making waves monetary set. Also signals to the markets that the Government is hell-bent on controlling inflation.
Therefore, there is no agreement among economists. It is clear that systems of fixed interest rate have reduced inflation almost miraculously. The example of Argentina is important: 27% a month (1991) 1% a year (1997)!
The problem is that this system creates a gap growing between the stable exchange rate – and the level of inflation falling slowly. This, indeed, is the opposite of devaluation – currency can be seen, becomes stronger. Real exchange rates strengthen a 42% (Czech Republic), 26% (Brazil), even 50% (Israel until recently, despite the fact that the exchange rate system there is almost fixed). This has a disastrous effect on the trade deficit: balloons and consumes the 10.4% of GDP.
This phenomenon does not occur on systems that are not fixed. Especially benign are mobile exchange rate and the mobile systems that keep pace with inflation, and not let the currency appreciate against the currencies of major trading partners. Even then, the important question is the composition of the basket of bonding. If the exchange rate is linked to a major currency – the local currency appreciate and depreciated along with major currencies. In a way the main currency inflation is, therefore, imported through the mechanism of currency. This is what happened in Thailand as the dollar strengthened on world markets.
In other words, the design of the parity system fixed exchange rate and is the crucial element.
In a system of mobile broadband – the wider band, minor is the volatility of the exchange rate. This European monetary system (EMS – ERM), known as “The Snake”, had to line up a couple of times during the 1990s and each time the solution was to expand the bands in which Exchange rates could fluctuate. Israel had to do it twice. On June 18, the band doubled and the shekel can be up and down by 10% in each direction.
But Exchange rates fixed offer other problems. The strengthening real exchange rate attracted foreign capital. This is not the type of foreign capital, countries are seeking. It is not the foreign direct investment (FDI). It’s hot money, hot in search of yields ever higher. Its objective is to benefit from the stability of the exchange rate – and of the high interest rates paid on deposits in local currency.
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