Devaluation: What is it really?

It appears to me that many a people, even the well-educated fellows have got difficulties in understanding what Devaluation really is. I therefore took the trouble of assembling and remembering all that I have read and studied about the subject and I hereby present the same with the hope that the readers will get to understand the crux of the matters of devaluation.

Defining Devaluation

Take a closer look at the following three definitions from different websites

  1. en.wikipedia.org/wiki/devaluation: the reduction in value of a currency with respect to those goods, services and other monetary units with which that currency can be exchanged.
  2. Web definitions: an official lowering of a nation’s currency relative to that of other countries
  3. www.investorglossary.com/devaluation: the reduction in value of a currency relative to all other currencies.

You will notice that the important words in all the three definitions are: Reduction of a currency. You would also realize that definition number two recognizes this reduction of a currency as official. That tells us that the value of a currency can be reduced unofficially. That however is given another term which is Depreciation. So whether the nation wants it or not, a currency may increase in value (appreciation) or decrease in value (devaluation).

The other thing you would observe from the definitions above is that devaluation happens in respect to something. That can be a currency of another nation, a service offered by someone or indeed goods on the market. But if we have definitions with those variations, we will have tough time in coming up with the percentages of devaluation or its opposite, revaluation.

But how does this happen? What causes the currency to decrease or increase in value? And how do people come to determine that the devaluation is 20 or 40 or indeed 47.9 percent? Economists will come in very quickly and tell us that it is the market that determines what happens to the value of a currency. Well that is all true but somehow partially.

Important knowledge that is needed

To understand this subject, one must read about how money came into existence. If we have that knowledge, it will enable us to come up with a standard against which a currency is measured. Money is a medium of exchange. You will also encounter a definition of money like; it is anything that is widely used for making payments and accounting for debts and credits. So, any material that can be used as a means of exchanging goods and services has the right to be called money.

Originally, different parts of the world used different things as a medium of exchange. In Africa for example, it is recorded that people could use cattle, mannilas and whales teeth as mediums of exchange. According to recorded history in the bible times, people traded with Balm products, and some precious stones. In a couple thousand years ago gold and other precious stones have been used as money. It is from this that books have been written on how money and banking systems developed. Some old economics books in the Libraries of the University of Malawi (Bunda College specifically) has this information and while admitting that this information is not of my own, let me admit again that I won’t be able to specifically cite a book from which I got the material.

Origin of Coins

At the time when gold was the major medium of exchange in the civilized world, people used to weigh it and exchange it with whatsoever they wanted. When the stone became rare, the weight of the stone that was used in exchange for a fully grown bull for example, kept on being reduced. If for instance one kilogram of gold was able to buy ten bulls, then latter the same ten bulls could be bought with only half a kilogram of gold. Thus, the value of gold was increasing (revaluating) as gold became rarer while the value of a bull was decreasing (devaluating) simultaneously.

The scarcity of the metal led to the introduction of coins which were unprinted on either side until when kings discovered that some unscrupulous people used to remove some gold from the coins such that if a coin was weighing 200 grams initially, it could be realized that after a cycle or two of it in circulation, the weight could be 180 grams or so. Some crooks (merchants on the black market) used to remove that gold and accumulated wealth for themselves that way. Thus a prevention measure was to print a king’s face or anything on the two sides of the coins. And on its perimeter, lines were cut for the same purpose.

Origin of Banks and Bank Notes

How about paper money and the banks? Well if you were in a community and felt insecure keeping your gold in the house, you could take it to someone who had very good security (a bank) to keep it for you. They could in turn issue you a receipt with a promise which indicated that your gold will be given to you whenever you wanted it.

One could go far away with the receipt and while there they could realize that they needed something. But then their gold is not with them because it is being kept where they deposited it for safety. So one could go with their receipt to someone who had what they needed and negotiated that the use the receipt as a mode of exchange. In turn, this third party receiving the receipt would go with it to the bank and claim the amount of gold promised on it. The receipt became the bank notes. That is why the word promise is always there on every bank note.

How the Receipts Could Lose Their Value

From this then, it means the receipts in circulation should carry a promise which is equal in value to the deposited gold at the bank. If gold was still used today as a standard, then it means people would go to the Reserve Banks and claim their gold back. But that is not the case today. Now what would happen, when those merchant crooks got some gold from the stores where people thought they could get some security? The answer is simple.

The receipts in circulation would show more gold in bank than there really was. Initially, the ratio of gold in the bank to that promised in the receipts was supposed to be 1:1. But eventually, due to the above case, the ratio of gold in the bank to that promised in receipts in circulation would be reduced to 1:2. The kings would have no option but to accept that something went wrong in their storage system and that instead of the promised amount on the receipts, the value would be reduced with a certain percentage. That is DEVALUATION! The value shown on the receipt has been reduced and you will use it less than you initially could.

And how does that fit in today’s civilized economy world? Ok, just replace the US Dollar with the gold. Why? I won’t explain that in detail for I fear it may be classified. But, dollarization may try to explain what happened.

Dollarization

Definitions for this will come out as the adoption of a foreign currency for use in a country in which the local currency has lost its value. One recent case which demonstrates this is Zimbabwe where, the Zimbabwe Dollar was replaced by the US Dollar. But if you read deeper about dollarization, you will discover after much research that it is the acceptance of the US Dollar as a universal currency that can be used in the place of gold. Why? Probably because the United States of America being the only “most stable economy in the world”( No offense to any other stable economy) is the only one which can give back “gold” to every nation. Thus, instead of gold, the world used the US$ as a standard for revaluation and devaluation.

Is Devaluation Important in Any Sense?

Yes! Actually in many senses but since this document seems to be a long one, I will only mention the major one. As a country, devaluation will always occur if the US$: Local currency ratio decreases and vice versa. You may remember that the word Devaluation is official. Unofficially, things may already have shown on the market that a country has less gold (US Dollars) than the receipts (bank notes) that is in circulation. That is highlighted especially when people go to banks to demand for the gold (US Dollars) for use outside the country only to be told that the commercial banks don’t have any! That is what is called Depreciaton.

So if the leader is rejecting to make official the depreciation that is on the market, they imply that their country has enough gold (US Dollars) to run all of its activities. How negative is that? It is, because you will only help someone who admits that he has a problem and needs your help. But if someone has a problem, and yet they don’t want to admit it, you won’t feel pity for them and there is no way you can help someone who doesn’t need help.

When IMF was pleading with our late Leader and President Bingu wa Muntharika, they were only saying, admit that as a nation, something has gone wrong in the banking system/or money market and that you don’t have enough gold (US dollars) so that donors should actually come in and help!

Bad Side of Devaluation

Do I say that that there are no immediate effects on the people? No! It really has and people (both in urban and rural) feel its pinch when in the short term prices of goods and services rise. It is like a king admitting that something went wrong with their storage system and whoever that king owed some gold, the value has decreased. But in the long run, doors are opened and those who can help come in and assist.

Employees Benefits

In the same short term, employees have a basis to build on their claim for salary increase. They will argue that the increment is inevitable basing on the devaluation percentage and the inflation values on the market.

I hope you are not the same at all!

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