Competitive devaluation

Definition

Competitive devaluation is a strategy where a country intentionally lowers the value of its currency relative to others to gain a competitive advantage in international trade. This practice can influence the balance of trade by making exports cheaper and imports more expensive, potentially boosting domestic production and reducing trade deficits. However, it can lead to conflicts among nations as countries may retaliate with their own devaluations, resulting in a cycle of currency wars.

5 Must Know Facts For Your Next Test

1. Countries often resort to competitive devaluation during economic downturns to stimulate exports and revive growth.
2. This practice can lead to inflationary pressures domestically, as imported goods become more expensive.
3. Competitive devaluation may provoke retaliation from trading partners, escalating into broader trade conflicts.
4. It undermines trust in international monetary systems, potentially leading to increased volatility in currency markets.
5. Long-term reliance on competitive devaluation can harm domestic industries by discouraging innovation and efficiency improvements.

Review Questions

• How does competitive devaluation influence a country's balance of trade?
  • Competitive devaluation influences a country's balance of trade by making its exports cheaper for foreign buyers while simultaneously increasing the cost of imports. This can lead to an increase in export volumes, potentially reducing trade deficits. However, if multiple countries engage in this practice, it can negate the benefits, as other nations might also devalue their currencies in response, leading to no net gain in trade balances.
• Discuss the potential negative consequences of competitive devaluation on international relations.
  • Competitive devaluation can have several negative consequences on international relations, including escalating tensions between countries engaged in currency manipulation. As nations retaliate with their own devaluations, it can create a cycle of mistrust and conflict, damaging diplomatic relationships. Additionally, it may lead to trade wars that disrupt global supply chains and economic stability, further straining relations between affected countries.
• Evaluate the long-term impacts of competitive devaluation on a country's economic health and global standing.
  • The long-term impacts of competitive devaluation on a country's economic health can be detrimental, as continual reliance on this strategy may lead to structural issues within the economy. While initial gains may be seen in export levels, persistent devaluation can lead to inflation and reduced purchasing power domestically. Moreover, a country's global standing may suffer as it becomes known for manipulative practices, potentially resulting in decreased foreign investment and diminished credibility in international economic forums.

Related terms

Currency war: A situation in which countries compete against each other to achieve a lower exchange rate, often through monetary policy interventions.

Exchange rate: The price of one country's currency in terms of another currency, which can fluctuate due to various economic factors.

Balance of payments: A record of all economic transactions between residents of a country and the rest of the world over a specific time period, including trade in goods and services.