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Currency Devaluation
Devaluation refers to the act or process of reducing the quality or value of something. When discussing fiat currencies, devaluation historically referred to the practice of reducing the precious metal content in coins while keeping the nominal value constant, thus diluting the intrinsic value of the coins. In a modern context, devaluation has evolved to refer to the decline in the value or purchasing power of a currency—such as when central banks increase the money supply, thereby reducing the nominal value per unit.
Understanding Devaluation
Before the advent of paper money and coins made of cheaper metals like nickel, currency consisted of coins made from precious metals such as gold and silver. These were the most popular metals of the time, valued beyond government fiat. Devaluation was a common practice aimed at saving precious metals by mixing them with lower-value metals.
This practice of mixing precious metals with lower-quality metals meant that authorities could mint more coins with the same face value, thereby expanding the money supply at a fraction of the cost compared to coins with higher gold or silver content.
Today, coins and banknotes have no intrinsic value; they are merely tokens representing value. This means that devaluation depends on supply: how many coins or banknotes the issuing authority allows to circulate. Over time, devaluation has undergone different processes and methods. Thus, we can define old and new methods.
Traditional Methods
Before the advent of paper money, clipping, shaving, and plugging were the most common methods of devaluation. These methods were employed by both malicious coin counterfeiters and authorities seeking to increase the circulation of coins.
Clipping involved "shaving off" the edges of coins to remove some of the metal. The resulting clippings would be collected and used to manufacture new counterfeit coins.
Shaving entailed vigorously shaking bags of coins until the edges of the coins wore off and fell to the bottom. These clippings were then collected and used to create new coins.
Plugging involved punching a hole in the center area of a coin and then hammering the remaining portion to close the gap. Coins could also be sawed in half, with a piece of metal removed from the interior, then filled with cheaper metal, and finally fused back together. These techniques were gradually phased out with the advancement of modern coinage technology.
Modern Methods
Increasing the money supply is a modern method used by governments to devalue currency. By printing more money, governments can obtain more funds for spending, but this results in inflation, as it reduces the nominal value per unit of currency.
Governments may devalue currency by increasing the money supply, lowering interest rates, or implementing other measures that encourage inflation; all of these are "good" ways to decrease the value of currency.
Why Money Devalues?
Governments devalue currencies to obtain expenditure without further raising taxes. Devaluing currency to fund wars is an effective way to increase the money supply, allowing participation in costly conflicts without affecting individuals' finances—at least that's the perception.
Whether through traditional currency devaluation or modern printing methods, increasing the money supply can bring short-term benefits to stimulate the economy. However, in the long run, it leads to inflation and financial crises. This impact is most directly felt by those in society who lack hard assets to counter currency devaluation.
Malicious actors introducing counterfeit currency into an economy can also lead to currency devaluation, although in some countries, the consequences of being caught may result in the death penalty.
"Inflation is the legitimate form of counterfeiting, counterfeiting is the illegal form of inflation." — Robert Breedlove
Governments can take measures to mitigate the risks associated with currency devaluation, preventing economic instability and weakness, such as controlling the money supply and interest rates within specific ranges, managing expenditures, avoiding over-borrowing, etc.
Economic reforms that increase productivity and attract foreign investment also help maintain confidence in the currency and prevent currency devaluation.
Real-World Examples
Roman Empire
One of the earliest examples of currency devaluation dates back to around AD 60, during the rule of Emperor Nero in the Roman Empire. Nero reduced the silver content of the denarius coin from 100% to 90% during his reign.
Emperor Vespasian and his son Titus invested heavily in reconstruction projects after internal wars, such as the construction of the Colosseum in Rome, compensating victims of the eruption of Mount Vesuvius, and the Great Fire of Rome in AD 64. The means chosen to cope with the financial crisis were to reduce the silver content of the denarius from 94% to 90%.
Titus's brother and successor Domitian saw the value of having "hard currency" and the stability of a properly supplied currency, so he raised the silver content of the denarius to 98%—only to have to reverse this decision when another war broke out. Currency devaluation once again enveloped the entire empire.
This process continued gradually until the silver content was only 5% over several centuries. With the continued devaluation of currency, the empire began to experience severe financial crises and inflation—especially in the third century, sometimes referred to as the "Crisis of the Third Century." During this period, from AD 235 to AD 284, Romans demanded higher wages and increased prices for the goods they sold to cope with currency devaluation. The era was characterized by instability, external pressures from barbarian invasions, as well as internal issues like economic downturns and plagues.
It wasn't until Emperor Diocletian and later Constantine took various measures, including introducing new coins and implementing price controls, that the Roman economy began to stabilize. However, these events highlighted the fragility of the once-mighty Roman economic system.
Ottoman Empire
During the Ottoman Empire, the official currency unit, akçe, was a silver coin, whose silver content declined from 0.85 grams in the 15th century to 0.048 grams in the 19th century. The measure of reducing the intrinsic value of coinage to manufacture more coins and increase the money supply. The new currencies, the kuruş in 1688 and the lira in 1844, gradually replaced the original official currency akçe due to its continuous devaluation.
Henry VIII
During the reign of Henry VIII, England needed more money, so his Chancellor of the Exchequer began using cheaper metals like copper to lower the cost of coins, enabling the manufacture of more coins at a more affordable cost. By the end of his reign, the silver content of the coins decreased from 92.5% to only 25%, enabling more money to be earned and funds provided for the exorbitant military expenses required for the European wars of the time.
Weimar Republic
During the 1920s in the Weimar Republic, the German government met its war and post-war financial obligations by printing more banknotes. This measure reduced the value of the mark from about 8 marks per US dollar in 1914 to 4.2 trillion marks per US dollar at the height of the painful hyperinflation, culminating in the collapse when the mark reached 4.2 trillion marks per US dollar.
These historical episodes serve as stark reminders of the dangers of monetary expansion. These once-powerful empires are cautionary tales of modern fiat systems. As these empires expanded the money supply, devaluing currency, they were in many ways like the well-known frog in boiling water. The temperature—or in this case, the speed of currency devaluation |
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Post time 28-3-2024 10:01:05