Reasons That Can Cause the Dollar to Devalue
When there is dollar devaluation, the currency declines in value compared to another country’s currency. The Canadian dollar can depreciate due to unfavourable economic conditions like changes in interest rates. As a result, exchange rates are affected.
Although countries maintain and grow their economy to ensure the steadiness of the currency, other factors can cause devaluation. Inflation, demand for currencies, and a change in export prices are among the factors.
With this guide, you will learn the factors that influence the dollar value, the causes of dollar devaluation, and its effects on the market.
Effects Of Dollar Devaluation
Before we look at the reasons for a dollar devaluation, let us first look at the effects of the depreciation. A reduction in currency strength could have positive results, but most effects are adverse and affect the entire economy.
1. Exports Are Cheaper To Foreign Countries
A fall in the Canadian dollar is advantageous to countries that export commodities to Canada. Because the exchange rates are lower, they will pay less than they used to pay.
However, this is a disadvantage to Canada because they will be gaining less profit from the exports. The country should aim to regulate the prices of their commodities or work on political stability for the economy to grow.
2. Expensive Imports
Devaluation of the dollar also leads to expensive imports. If the imported items are raw materials, there will be less production of commodities, leading to shortage.
When imports become expensive and exports are cheaper, there will likely be inflation. The manufacturers are spending more on production and gaining less because of the low demand and cheap exports.
Over time, the cost of commodities may increase. The abrupt increase in the prices of products leads to inflation, hurting the country’s economy.
4. Fewer Investors
When the country’s currency devalues, it becomes less attractive to investors. They start gaining fewer profits because the economy is declining.
Also, with the increase in the cost of production, companies may scale back their workforce and reduce wages. This affects the general growth of the country’s economy.
Causes Of Dollar Devaluation
There are many causes of currency devaluation, and the above effects can be signs. When a country’s imports decline, or there is an increase in market prices or a lack of goods in the market, it could be because imports are too expensive.
Some of the possible causes of currency devaluation are:
1. Monetary Policy
Countries have different monetary policies to maintain price stability in the economy. While some strategies are favourable to the economy, others can have negative impacts.
For example, when the Bank of Canada reduces interest rates, investors can borrow more money to start and run businesses. There will be business growth in the country, leading to economic growth. However, increased interest rates discourage investors from taking loans, thus, slowing business growth.
In addition, other monetary policies, like purchasing bonds to increase the money in circulation, could lead to currency devaluation. When there’s more cash in circulation than the goods available, the currency loses value, hence depreciation.
Inflation is the increase of market prices, affecting currency depreciation or appreciation. High inflation in the country leads to lower currency value. When the market prices are high, there is lower demand for goods and services.
Also, when the commodity prices are high, the country exports less because there are fewer foreign customers. Less foreign exchange also leads to a decrease in the currency’s value.
3. Currency Demand
A rise in the demand for a country’s currency strengthens it. When Canada exports commodities to a particular country, the buyers pay in Canadian dollars, meaning more investors will strive to get the Canadian currency.
Also, if the country’s currency is used to purchase costly commodities like gold and oil, its demand stays high, hence a high value. When oil and gold sellers start accepting other currencies, it lowers the value of the currently used currency.
4. Lower Export Prices
A fall in export prices of Canadian main export products can lead to Canadian dollar devaluation. For example, oil is a significant export in Canada. When countries stop getting oil from Canada, there is less demand for the CAD in those countries, hence a devaluation.
Does A Country Benefit From Currency Devaluation?
Currency devaluation favours some countries’ investors who export the products to their countries. Since the citizens of the other countries can get the commodities at a lower price, it increases demand.
Therefore, these investors sell more and make more profit because the goods are not sold in Canada. On the contrary, dollar depreciation is bad news for investors who import raw materials for their industries in Canada.
A fall in the CAD value increases importation prices. Therefore, the cost of production rises, leading to an increase in the prices of the goods. Due to the reduction in dollar value, exports are cheap, so the investors make little to no profit.
Alternatively, investors increase the prices of its commodities to earn a profit from the high production cost. The higher prices lower the demand, so very few customers buy the products.
How The Country Can Increase Currency Value
Currency devaluation can negatively affect a country, but these practices can help them regain their currency value.
1. Reduce Inflation
When the country’s market prices are stable, demand rises because goods are attractive to more people. This leads to market growth and increases the country’s currency.
2. Favourable Monetary Policies
The government should formulate better monetary policies like decreasing bond prices and increasing interest rates to reduce inflation. This reduces the money supply among people, hence a steadiness in market prices.
3. Stable Political Climate
If the country is peaceful, more investors will want to invest there. A non-violent country is also a safe place to have your business because you are sure of price stability. With more investments, there is more employment.
The country is also very productive, making more exports and having many customers. More money coming in means more economic growth and no chance of inflation. It also ensures competition with the other countries, keeping their currency at the top.
Also, a politically stable Canada sells a lot of oil through export. Since there is steadiness in the business, the prices are stable, maintaining the stability of the currency level.
There are many reasons for dollar devaluation. Canada should monitor its monetary policies, political stability, and inflation rates to ensure the CAD remains valuable. A depreciation in the currency can cause many adverse effects on the market. Thankfully, KnightsbridgeFX can help you save money even when the Canadian dollar devalues.
Contact us today to talk to our professionals about your currency exchange.