Devaluation By Rughoobar Chidanand

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Devaluation, in economics, official act reducing the exchange rate at which one currency is exchanged for another in international currency markets. A government may choose to devalue its currency when a chronic imbalance exists in its balance of trade or overall balance of payments, which weakens the international acceptance of the currency as legal tender.

The lowering of a currency value by devaluation occurs when a country has been maintaining a fixed exchange rate relative to other major foreign currencies. When a flexible exchange rate is maintained—that is, currency values are not fixed but are set by market forces—a decline in a currency's value is known as a depreciation.

The free-market value of a national currency is determined by the interaction of supply and demand. If the quantity of the currency demanded is greater than the quantity supplied, a nation will experience a balance of payments surplus. A balance of payments deficit exists when the quantity of currency supplied is greater than that in demand.

The demand for a nation's currency depends on the amount of its exports, domestic investments, and assets held in domestic currency. A nation's currency supply on world markets depends partly on the amount of imports, investments abroad, and assets held in foreign countries. Ultimately, the supply of a currency depends on national monetary policy; if a country prints too much money, causing inflation domestically, a balance of payments deficit results.

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Under a system of fixed exchange rates a country can adjust its balance of payments by trading its national currency for foreign currency or gold. If a balance of payments surplus persists, the government may decide to buy more foreign currency or gold in order to move back into equilibrium. Conversely, if a deficit exists, the government may sell some of its reserves of foreign currency or gold in order to bolster the value of its own currency. Because a nation's reserves of other currencies and gold are limited, the government may choose to correct an imbalance by officially readjusting ...

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***** This essay is excellent as far as it goes. Fixed exchange rates are unlikely to return in the forseeable future so I would have preferred to see more discussion of the floating exchange rate situation.