Common Stocks & Devaluation

Devaluation happens when a country formally lowers the exchange rate of its currency against one or all other currencies, or doesn't support it when the markets value it lower. A country might choose to devalue its currency to raise its volume of exports in the world market. Devaluation makes a country's exports less expensive to buyers using other currencies. Devaluation also makes that country's imports more expensive to its citizens. Rising cost of imported goods can result in price inflation and -- unless its export volume increases substantially -- can result in slowing the country's economic growth .

Rising export volume can improve a country's economy because the country is producing more goods and services and employing more people in its companies. A stronger economy is normally reflected in higher stock prices. To a certain point, devaluation also increases domestic consumer demand for its domestically produced products, because imported products are too expensive. If inflation results, even prices on domestically produced products will rise. In the United States, the Federal Reserve may step in to fight inflation by raising interest rates, which discourages borrowing and slows the economy. However, higher interest rates also attract foreign investment in U.S. bonds.

In any country, when the currency loses its buying power because of inflation or devaluation, that is called currency depreciation. Devaluation depreciates the value of the currency on the world markets and raises the prices of imported goods. Inflation depreciates the value of money because there is too much money chasing a fixed amount of goods and services, so prices rise. Devaluation also makes it less expensive for companies in some foreign countries to borrow money in the country that devalued its currency. As long as foreign currencies maintain their strength against the devalued currency, foreign borrowers will spend less money paying off those loans than they would paying off loans in their own countries' currencies. Additional loan demand from foreign borrowers increases the money supply, and that can cause inflation.

In general, currency devaluation increases stock prices because it makes stock investments less expensive for foreigners, who often are betting that the devalued currency will rise or revalue higher. It also increases a country's production of goods and services to meet export demand, and that means domestic companies make more money, which tends to raise their stock prices. On the other hand, it discourages investment in foreign countries and keeps more money in the domestic economy.