What Is a Weak Currency?
A weak currency refers to a nation's money that has seen its value decrease in comparison toother currencies. Weak currencies are often thought to be those of nations with poor economic fundamentals or systems of governance. A weak currency may also be encouraged by a country seeking to boost its exports in global markets.
Currencies weaken and strengthen against each other for a variety of reasons but economic fundamentals do play a primary role.
Key Takeaways
- There can be many contributing factors to a weak currency but a nation's economic fundamentals are usually the primary reason.
- Export-dependent nations may actively encourage a weak currency in order to boost their exports.
- Currencies can also be weakened by domestic and international interventions.
- Currency weakness or strength can be self-correcting in some cases.
Understanding a Weak Currency
Fundamentally weak currencies often share some common traits. They can include a high rate of inflation, chronic current account and budget deficits, and sluggish economic growth.
Nations with weak currencies may also have much higher levels of imports compared toexports, resulting in more supply than demand for such currencies on international foreign exchange markets if they're freely traded.
A temporary weak phase in a major currency provides a pricing advantage to its exporters but this advantage can be wiped out by other systematic issues.
Examples of Weak Currencies
Currencies can also be weakened by domestic and international interventions. China's devaluation of the yuan in 2015 followed a long period of strengthening. The imposition of sanctions can have an immediate effect on a country's currency. Sanctions weakened the Russian ruble in 2018 but the real hit came in 2014 when oil prices collapsed and the annexation of Crimea set other nations on edge when dealing with Russia in business and politics.
Perhaps the most interesting example is the fate of the British Pound as Brexit neared. The British pound (GBP) was a stable currency but the vote to leave the European Union set the pound on a very volatile path that saw it weaken in general as the process of leaving plodded along.
Supply and Demand in Weak Currencies
Like most assets, a currency is ruled by supply and demand. When the demand for something goes up so does the price. The price of the yen goes up and the yen becomes a strong currency if most people convert their currencies into yen. More dollars are needed to buy the same amount of yen so the dollar becomes a weak currency.
Currency is a type of commodity. An individual is selling their dollars and buying yen when they exchange dollars for yen. A currency's value often fluctuates so a weak currency means more or fewer items may be bought at any given time. The dollar is a weakening currency when an investor needs $100 to purchase a gold coin one day and $110 to purchase the same coin the next day.
Pros and Cons of a Weak Currency
A weak currency may help a country's exports gain market share when its goods are less expensive compared to goods priced in stronger currencies. The increase in sales may boost economic growth and jobs while increasing profits for companies that are conducting business in foreign markets.
American exports tend to increase when purchasing American-made items becomes less expensive than buying from other countries. In contrast, exporters face greater challenges selling American-made products overseas when the value of a dollar strengthens against other currencies.
How Does a Budget Deficit Work?
A budget deficit occurs when a government spends more money than it collects. This can be the result of an ailing economy, a recession, or high unemployment rates. The government collects less in taxes when citizens are working and earning less.
Why Did China Devalue Its Currency?
China's economy was believed to have been ailing just before it devalued its currency in 2015. The move was said to have been made to revitalize the country's exports. China's economy was heavily dependent on exports at that time. The decrease was made against the U.S. dollar.
How Strong Is the U.S. Dollar?
The strength of the U.S. dollar rose to a 20-year high in 2022 but it had weakened by the end of August 2023. It was weaker than both the British pound and the euro at that time.
The Bottom Line
Currency strength or weakness can be self-correcting. More of a weak currency is needed when buying the same amount of goods priced in a stronger currency. Inflation will climb as nations import goods from countries with stronger currencies. The currency discount may eventually spur more exports and improve the domestic economy if no systematic issues are weakening the currency.
In contrast, low economic growth may result in deflation and become a bigger risk for some countries. Consumers may postpone spending and businesses may delay investing when they begin expecting regular price declines. A self-perpetuating cycle of slowing economic activity begins and this will eventually impact the economic fundamentals supporting the stronger currency.
