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(6)BalajiViswanathan'sanswertoHowdocountriesdevaluecurrency?Quora

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BalajiViswanathan
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BalajiViswanathan,MBAfromBabson
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Balajihas310+answersand178endorsementsinEconomics.

On6thJune,1966India,hitbydroughtaftertwomajorwars(withChinaand
Pakistan),devaluedrupeebyamassiverate:fromRs.4.76=$1toRs.7.50=$1
(57%devaluation).AgaininJuly1991,hitbygulfwarandcollapseofSoviet
Union(India'smaintradingpartnerthen),Indiadevaluedrupeefrom
Rs.18=$1toRs.25to$1.[JuneisabadtimeforIndianrupee]
HistoricalExchangeRateRegimeofAsianCountries
Devaluationisusuallyaconsciousprocessofcontrollingcurrencyinafixed
rateregime.Todothis,thegovernment(thatcontrolstheforexmarkettightly)
justhavetoannouncethattheyaremovingtoanewlevelagainstthedollar.

Letmeusethisopportunitytoexplainhowexchangerateswork.
ThestateofEarthopiahas3villagesKumarville,HuvilleandJohnville.
Initiallytheywereallselfsufficient,witheachofthevillagesproducingallthe
rice,vegetables,brickandclothesrequiredforalltheirinhabitants.Thingsare
workingsogreatsinceeternity.

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Now,somevillagersinJohnvillefoundanew,fasterwaytomakebricks.Thus,
theystartedproducingfasterthanthevillagerstherecouldbuy.So,they
thoughttheycouldsellsomeofthemtothevillagersinHuvillethatisgoing
througharainyseason.Inreturnforthebricks,Huvilleguysthankfullygave
someextrarice.Johnvilleguysdidn'tneedmuchrice,sotheywerewillingto
offeronlyoneextrabrickforevery10bagsofrice.
Meanwhile,Kumarvilleisgoingthroughadroughtseasonandgotobegthe
Johnvilleguys.SotheJohnguysgivethembagsofrice,inreturnforthelarge
pileofclothes.
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Theexchangeprocesswashowevercomplex.Thebartersystemhadsomany
issues(seemorehere:Whatwouldaworldwithoutmoneybelike?)So,atribal
leaderfromJohnville,letuscallhimHamilson,thoughthecouldusesome
speciallymadecoins.HecallsthespeciallymadecoinsDaluro.Hesets1brick
equals1Daluro.Thus,HuvilleandKumarvilleguysneedtogettheseDaluroto
buystufffromJohnvilleguys.
Nottobeleftbehind,thetribesofKumarvilleandHuvillegivecolorfulnames
RapiandRambitotheirowncoins.1Rapiissetas10pairofclothesand1
Rambiissetas10bagsofrice.Thesecoinsarethenusedamongthevillagersto
buyandsellstuffamongthemselves.Atthecurrentrate:1Rapi=1Rambi=1
Daluro.Equation1.
LifeissogoodforJohnvillepeopleastheyaregettingalotof,clothesandrice
withoutworkingmuch.Asthebrickguyskeepworkinghard,othersstart
relaxingmore.thenewtriballeaderBurnkeBunishappywiththis.
ThedroughtinKumarvilleendsandtheystartproducingalotofrice.Now,
theyarenotinthatneedforthericefromJohnvilleandhavealessneedfor
Daluro.Asricheisrequiredless,Kumarvilleguysarewillingtosellonly5
clothesforevery10bagsofrice.Bypreviousequations,now1Rapi=10clothes
=20bagsofrice=2Daluro.
https://www.quora.com/Howdocountriesdevaluecurrency/answer/BalajiViswanathan2

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8/15/2015

(6)BalajiViswanathan'sanswertoHowdocountriesdevaluecurrency?Quora

Inthemeanwhile,Huvillehaveadaptedapartofbrickbuildingprocessand
havestartedproducingenoughbricks.Theyarenowlesswillingtobuybricks
fromJohnville.Theynowset1Rambi=10bagsofrice=3bricks=3Daluro.
ThisleavestheJohnvilletribeswithnooptionsbuttodevaluetheircurrencyto
accepttherealitythat1Daluro=0.5Rapi=0.33Rambi.Thisspursthelocal
farmersandweaverswhocannolongerbuyriceandclothesefromoutsideand
startgettingbacktoworkagain.

Devaluationisessentiallyrecognizingthatone'scurrencyissignificantlyless
thanwhatitusedtobe.Thishappenswhenacountryisnotlettingitscurrency
tradeinthemarketsandessentiallysetshowmuchitscurrencyissettoa
dollarorothercurrency.Devaluationisasudden,overnightchange.

Otheranswersareconfusingthenaturalprocessofcurrencydepreciation
(throughinflation)withdevaluation.Devaluationmeansacountry's
government(andcentralbank)announcesovernightabigchangeinthe
country'sexchangerate.Itisusuallyaconsciousprocessofcontrolling
currencyinafixedrateregime.Todothis,thegovernment(thatcontrolsthe
forexmarkettightly)justhavetoannouncethattheyaremovingtoanewlevel
againstthedollar.

1.CurrencyDevaluationandRevaluation
2.TheImplicationsofCurrencyDevaluation
34,133views1,255upvotesWritten14Feb,2013AskedtoanswerbyTusharGupta

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