Why Do Countries Undervalue Their Currency

When US Dollar is stronger, for example, individuals generally assume that the economy is getting better and there is high demand of US Dollars. This means many countries buy more US Dollars in the open market for the purpose of trade. Then of course if US Dollar weakens, this means there is less demand for the currency in the market; less export and or business coming in the United States. The value of US Dollar becomes less against to that of another country. Thus, to everyone’s knowledge it is bad news for the country’s currency to be of less value. So why would a country choose to undervalue their currency? What is the advantage in that?

It is no secret that China is one of the fastest growing countries today economically and yet, they chose to undervalue their currency. So let’s take a closer look as to how this is being played.

Reputable companies have long been outsourcing to other countries. China is one most known to all. This explains why everything we buy nowadays is made from China; from toys, gadgets, to chocolates! China is relying on it’s export for economic growth and with their currency undervalued, all from labour to goods are affordable.  Businessmen from Europe or from the US can get more products with their money.

Say for example purchasing Transcend micro SD cards. If these SD cards were produced in the US, labour is expensive and naturally, the product is expensive. Let’s say, you’d pay 50USD for a good one but if produced in China, you can get two SD cards for the same price. There is a higher purchasing power if products are bought from China.

Now same is true with outsourced services. India at some point was highly known to offer affordable service which led to the growth of the BPO Industry. India’s currency is also undervalued. A Europe Based company can hire two times more the manpower to handle their customer service department.

What we’ve covered so far is just the bigger picture. There are little things like when a country’s currency is undervalued; many foreigners also consider relocating not just their business but their families. With everything so expensive in their home country, it makes them feel secure to live in another where basic necessities are more than just secured. Like the above mentioned examples, this also further increases the demand of the undervalued currency.

In theory, if the demand of Chinese Yuan, for example, is high the currency’s exchange rate should increase.  But, still countries like China choose to set a fix undervalued rate on their currency. This would mean a negative effect to other country’s demand for goods.

Of course what’s fair is a country’s currency should not be kept undervalued if the demand of the currency is high. These countries then face a great deal of pressure from those who were affected by this practice. However, they are also looking out for what is best for their economy. Greater exchange rate could risk the demand for their products and services.