"Currency devaluation" is a phrase that no one wants to see in the headlines. It usually becomes a topic of conversation when financial institutions worry about the health of the economy. However, the devaluation of currency is often confused with currency depreciation. Both tend to have similar outcomes but stem from different sources.
Currency devaluation occurs when the issuing government intentionally lowers the exchange rate, which only happens in a fixed exchange rate system rather than an open market system.
Devaluation of Currency Versus Currency Depreciation
Someone or some entity must intentionally cause devaluation, meaning that it is often a choice made by centralized governments. Depreciation occurs based on the actions of many people and entities, not just a few.
A country must have a fixed exchange rate system in place in order to experience the devaluation of the currency. This means that the US cannot experience currency devaluation as its currency is on a floating exchange rate. On the other hand, the currencies of Cuba, the United Arab Emirates, Saudi Arabia, Hong Kong and Panama all could be devalued as they are fixed based on the U.S. Dollar.
The government's central bank often has the intention of making the local currency – and thus local goods – more attractive to foreign buyers via devaluation, meaning increased exports. The foreign currency can buy a lot more than the devalued local currency.
The flip side of this situation is that domestic goods become more expensive for locals. Their money also becomes less valuable in the foreign market after devaluation, meaning foreign goods are nearly impossible to purchase due to the increased expense.
Currency depreciation, on the other hand, is determined by the ebb and flow of the open market. Based on how stocks are traded and investments are handled, the exchange rate between the domestic currency and foreign currency will change over time.
What Is a Strong or Weak Dollar?
The U.S. dollar is sometimes referred to by economists as "strong" or "weak." This is in comparison to foreign currencies and how much purchase power the dollar has in foreign economies. If 1 USD can be exchanged for 1.20 EUR, the dollar is considered the weaker currency. However, if the exchange rate between USD and EUR changes so that 1 USD now equals 1.15 EUR, the dollar would be called "strengthening" because it improved over time.
But it's not just the U.S. dollar that can be called strong or weak, or strengthening and weakening. Any currencies can be described using these terms. Just keep in mind that this terminology always describes a relationship between two currencies. The U.S. dollar might be strong compared to some currencies and weak compared to others.