Devaluation facts for kids

Imagine money as something that can change its value. A devaluation happens when a country's government or central bank officially decides to make its own money worth less compared to other countries' money. This usually happens when a country uses a "fixed exchange rate" system. This means the government sets a specific value for its money against another currency, like the US dollar, or a group of currencies.

When a country devalues its money, it means its central bank will now buy and sell foreign money at a lower rate. The opposite of devaluation is called a revaluation. That's when a country makes its money worth more.

It's important to know that devaluation is different from depreciation. Depreciation happens when the value of a currency goes down because of market forces, like how much people want to buy or sell it. This happens in a "floating exchange rate" system, where the market decides the value, not the government.

Devaluation is also different from inflation. Inflation means that money can buy fewer goods and services over time. It's about how much your money is worth inside your own country, not against other countries' money.

How Devaluation Was Used in the Past

Historically, money was often made of valuable metals like gold or silver. Governments would make coins and promise they contained a certain amount of metal.

If a government needed more money but didn't have enough gold or silver, it might make coins with less metal. They would then say these new coins were worth the same as the old ones. This was a way of devaluing their money without telling anyone directly.

Later, when paper money became common, governments promised that paper money could be exchanged for gold or silver. If a government ran low on gold, it might announce that its paper money was now worth less gold. This reduced the value of everyone's money.

Why Countries Devalue Their Money

Countries that use a fixed exchange rate system try to keep their money's value stable. They do this by controlling how much money leaves or enters the country. Their central bank also buys or sells its own money using foreign money. This helps keep the value of their currency steady.

However, if a country buys a lot more from other countries than it sells (a "trade deficit"), or if a lot of money leaves the country, the central bank has to use its foreign money reserves to buy its own currency. This helps support its value.

But the central bank only has a limited amount of foreign money. If it looks like they might run out, they might decide to devalue their currency. This helps stop foreign money from leaving the country so quickly.

Sometimes, if people think a country is about to devalue its money, they might quickly sell that country's currency. This puts even more pressure on the country to devalue. When this happens, it can lead to a "balance of payments crisis." This means the country is running out of foreign money.

For example, this happened during the 1994 economic crisis in Mexico. The value of their money fell very quickly.

What Happens When a Country Devalues Its Money

Devaluing a country's money has big effects.

• Exports become cheaper: When a country's money is worth less, its products become cheaper for people in other countries to buy. This helps businesses sell more goods abroad.
• Imports become more expensive: At the same time, goods from other countries become more expensive for people in the devaluing country. This makes people buy fewer imported goods and more local products.
• Trade balance improves: These changes usually help a country sell more and buy less from other countries. This can stop the central bank from losing its foreign money reserves.
• Inflation risk: However, making imports more expensive can also lead to higher prices for goods inside the country. This is called inflation. If prices go up, people might demand higher wages. This can make the country's own products more expensive again, reducing the benefits of the devaluation.
• Economic instability: To fight inflation, the central bank might raise interest rates. This can slow down economic growth. Devaluation can also make money leave the country quickly, leading to economic problems.
• Impact on trading partners: A devaluation in one country can also affect its trading partners. They might lose trade income, and they might take their own actions to balance things out.

Devaluations in Modern Times

UK Economy

1949 Devaluation

After World War II, the British pound was set at a value of $4.03 US dollars. This was agreed upon at the Bretton Woods Conference in 1944.

After the war, Britain needed money. The US offered a loan, but only if Britain allowed its money to be freely exchanged for US dollars. When this happened in 1947, a lot of US dollars quickly left Britain. So, Britain had to stop the free exchange of money just seven weeks later.

By 1949, Britain's money was under pressure again. The Prime Minister, Clement Attlee, and his team decided to devalue the pound. On September 18, 1949, the value of the pound was lowered from $4.03 to $2.80. This was followed by cuts in government spending.

1967 Devaluation

When Harold Wilson became Prime Minister in 1964, his government found the economy was in a worse state than expected. Wilson did not want to devalue the pound. He remembered the problems from the 1949 devaluation.

To avoid devaluation, the government tried other things, like adding taxes on imports and borrowing money from other countries.

By 1966, the pound was under pressure again, partly due to a strike by sailors. Wilson still resisted devaluation and put in place measures to slow down the economy, including a wage freeze.

However, in 1967, more problems arose, including the Six-Day War and another dock strike. After failing to get help from other countries, the pound was finally devalued. On November 18, 1967, its value dropped from $2.80 to $2.40.

Other Economies

• China: The People's Bank of China devalued its money, the renminbi, twice in 2015. This was done to help its slowing economy. In 2019, China devalued its currency again because of a trade dispute with the United States.
• India: India devalued its money, the Indian rupee, by 35% in 1966.
• Mexico: Mexico devalued its money, the Mexican peso, in 1994. This happened before the North American Free Trade Agreement (NAFTA) and led to the Mexican peso crisis.

See also

In Spanish: Devaluación para niños