Understanding the Relationship between Devaluation, Beggar Thy Neighbor and Currency War
Let’s say an American wants to buy Indian products can only be bought by paying in Indian rupees. This means that the American cannot buy the Indian product unless and until he buys Indian rupees.
Therefore, if the Indian government reduces the value of the rupee, the American get more Indian rupees for every US dollar.
Let’s say earlier he would get Rs. 50 for every US dollar but after devaluation he gets Rs. 60 for every US dollar.
This means that after devaluation the American for 1$ can now buy a product for Rs. 50 and another for Rs. 10 whereas before the devaluation he was in a position to only buy one product of Rs. 50.
So clearly the buying capacity of a US dollar increases because of rupee devaluation.
Thus for the American the product which was costing $1 previously would now be available to him at less than $1.
To understand how many dollars it would now cost him, let’s look at the following: • If Rs. 60 = $1 • Then Rs. 50 = $? • The above equation means that Rs. 1 is 1/60 th part of a dollar in value • Hence Rs. 50 would be $(50 x 1/60) • And this works to $ 5/6 = $. 83
From the previous explanation one thing that gets clear is the fact that whenever a country devalues its currency, its exports get cheaper and attractive.
And when this happens, there is a possibility that America (as in this case where our example talks about America and India) would prefer buying products from India than let’s say its neighbors (who have not devalued their currency).
This policy of devaluing currency is also known as “Beggar Thy Neighbor” because it has the potential of harming the economy of neighboring countries by making their exports less attractive and causing a reduction in their exports.
This in a sense sets up a sort of war between two countries for a higher export market share. This war is known as “Currency War”.
Hope through this explanation you have now understood the following terms 1. Currency devaluation 2. Beggar thy neighbor 3. Currency wars
It is important to understand at this point the difference between “Currency War” and “Price War”.
In a “Price War”, two or more manufacturers resort to price cutting by reducing the price of their products. This happens within a country (domestic trade).
A “Currency War” in essence is a “Price War” except that it is in the international context.
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