The economy affects all spheres of human life, therefore it is necessary to know its terms and processes. The reason for this is the availability of money in the wallet and the need to use it as a payment instrument. Moreover, such concepts as devaluation, inflation and default are more often found in news reports. They mean different processes that adversely affect the economic development of the state. Of course, this affects personal well-being. And in what specifically takes money from the wallet and leads to a decrease in their purchasing power, it is necessary to understand in more detail.
Devaluation
Understanding what devaluation and default are, one should immediately pay attention to the fundamental difference between the processes. Read about it below. Devaluation is the economic process of reducing the value of the exchange rate of a monetary unit to another currency or reducing the gold share in providing national money. This is an unplanned phenomenon of economic decline, which leads to the inability to maintain the exchange rate at the same level.
In the narrow sense, devaluation is the reduction in the value of money, which implies a sagging rate. For example, the exchange rate of the currency “A” to the currency “B” was 1 to 1. Then, after the decline in the economic development of the country in which the currency “A” is used, its monetary unit became cheaper in relation to the currency “B”. In fact, it has fallen in price to all other currencies of the world. This interpretation allows us to reveal the concept of "devaluation" in simple language.
Default
Default is the refusal of an economic entity to fulfill previously taken credit or other debt obligations. It arises as a result of a recession or due to devaluation, high inflation or unsuccessful economic reforms. This means that the subject, namely the state, economic block, company or private person cannot give a loan due to the lack of available funds for this. By declaring default, the entity recognizes its insolvency, although upon receipt of a loan guaranteed return.
The default itself cannot occur when assets were pledged upon receipt of a loan. Then they are simply seized and become the property of the lender, and the debts of the borrower are written off. However, when there is no money to repay the loan, its own insolvency is declared. Strictly speaking, an economic entity is bankrupt. After that, it is necessary to consider scenarios that resolve the issues of what will happen in the event of default with the economy. Read about it below.
Devaluation and Default in the Economy
So what is devaluation and default? The term devaluation is considered from two perspectives: from the point of view of the previously existing “gold standard” and the current free (market) currency regulation. If we consider that the exchange rate of a monetary unit is regulated by the volume of gold and foreign exchange reserves, then devaluation is the process of reducing the gold and foreign exchange share in financially ensuring the stability of money. This example is relevant for the RMB, whose exchange rate is not in free regulation, but controlled by the People's Bank of China. Gold and currency support is also relevant for many other states.
The exchange rate of the monetary unit of other states is in free market “floating”. This means that the demand for a currency unit determines its price. This forms the exchange rate, that is, the value of the money of one state in the currency of another. In such circumstances, devaluation means a depreciation of one currency against all others.
Default, unlike the devaluation process, is a more destructive phenomenon. It means the lack of funds that must be repaid on loans. The entity, that is, the company, the state or a private individual, needs to recognize default. This means that he borrowed the amount of assets some time ago, but there is no way to return it to the designated term. Below, all similar processes that answer questions about what is devaluation and default are explained in more detail.
Common processes of default and devaluation
Having understood what devaluation and default are, it should be concluded that these are different processes and terms. Devaluation is only a decrease in the value of the currency, and default is a deep crisis of the economy, a complete lack of credit repayment opportunities. In processes such as devaluation and default, the difference is significant also because they can be applied to different entities. Devaluation applies only to the state, that is, to an entity that has its own monetary system and monetary unit. Default is a concept specific to an individual, company or state.
However, in these processes there are also some common phenomena, as well as common ground. The first community is the economic crisis: both devaluation and default occur when the economic system is insolvent. The second community is long-term negative consequences for reputation: both of these processes reduce the attractiveness of the monetary unit for investments and for storing capital. Otherwise, these concepts are different.
An unstable economy: paths to devaluation and default
What is the difference between default and devaluation, and where do these concepts come into contact? If everything is clear with the differences, then the common ground can be completely different. They should be disassembled in typical economic processes of states with undeveloped economies. For example, there is state “A” with a weak or unstable economy. In this country, a certain monetary unit is applied, which, after the abolition of the "Gold Standard", is provided with gold and currency reserves. The amount of this money is equal to the amount of goods released in the state.
Due to incorrect management accents or due to economic or commodity sanctions, the export profits of the state and its enterprises are reduced. Then the enterprises work "at the warehouse" or completely cease to produce. At the same time, foreign exchange inflows are reduced, which requires spending foreign exchange reserves to pay social benefits or unemployment benefits. As a result, the volume of gold and foreign exchange reserves is decreasing. This means that the country has fewer reserves to ensure the exchange rate. Investor confidence in it is declining, and the economy is ineffective. Depreciation occurs: the depreciation of a monetary unit in relation to other currencies.
Ways to Get Out of the Crisis
In such circumstances, states decide to obtain loans to invest in the economy. When loans are spent irrationally, that is, for example, they are not invested in stabilizing the economy, but are spent on social payments in order not to cause a decrease in confidence in the authorities, the result is obvious: the economy is not restructured, and there are still debts, the time has come to repay the loans. If the state is unable to pay debts on loans received or on government loans, it defaults. Then the problem is solved at the interstate level in order to find a solution to stimulate the economy so that the borrower repays the funds.
Contact Points for Devaluation and Default
According to the above example, two conclusions can be made: devaluation can be the engine of default. Secondly, default can become the driver of a new devaluation. That is, the emerging economic crisis and the lack of assets to pay off debts provoke a new devaluation. These are the so-called common ground of these concepts. By the way, they have nothing to do with inflation, which can also become a driver of the economic crisis.
Absurdity of the concept of "default of the ruble"
Another misconception is the default of the currency. So what is ruble default? This is a phenomenon that in reality cannot occur, although in theory this is possible. It will be characterized by such a deep collapse of the ruble currency that it will not be perceived as a means of payment abroad. For the ruble it will not be possible to buy even the minimum monetary unit of another state. This is what the default of the ruble is. If you recall Solzhenitsyn’s quotes, it will look like this: for our ruble they will be given only in the “face”.
The impact of devaluation and default on the economy
What is devaluation and default in terms of impact on the economy and on the balance of payments of economic entities? Devaluation is the process of official (or hidden) agreement that the national currency costs less than others, and there is either no money to stabilize its exchange rate, or their allocation is irrational. The result is a weakening of the currency rate, an increase in the value of other currencies and, more importantly, a decrease in investor confidence in the country's economy.
Default is also a process that “humiliates” the economy in the eyes of investors. Then the currency is insolvent for savings, because devaluation and default are also accompanied by a growing rate of inflation. Money then costs much less than before. This is felt even within the country, especially if it regularly “turned on the printing press” to issue new banknotes. By the way, devaluation does not have an effect on the country's domestic economy if it does not depend on imports. And inflation is fatal.
Positive and negative trading effects of devaluation
Devaluation has both positive and negative consequences. Among the positive, undoubtedly, the decline in the price of exported goods should be indicated. The state that conducted the devaluation sells goods to another country with a higher and more stable exchange rate, receiving it in exchange for products. These funds are a tangible profit.
In addition, for foreigners, such products are much cheaper than those purchased from countries with well-developed economies. This is a factor in increasing competitiveness in foreign markets. What to do in case of devaluation in this case? It's simple: work and sell. Search and diversify sales markets and try to gain a foothold in them. Departure of employees to work abroad also allows you to earn more, although this tactic harms the image of the country and threatens an “outflow of intelligence” abroad.
Negative effects of devaluation in trade
The negative effect of devaluation is a significant increase in the cost of imported goods. What should the state do in case of devaluation? It will most competently defend itself against imported goods through import substitution. This path is the most competent and balanced, because it allows you to limit the outflow of the necessary foreign exchange assets from the country's banking system. However, when the state cannot produce some goods, for example, part of food products, it is still forced to purchase them. Otherwise, the population faces food shortages. The third step that the state should not take is to print more money. This step will already harm the domestic market and will stimulate both a new devaluation and inflation.
Forecasts for the ruble devaluation
In 2015, the ruble was “released” into “free swimming” and is independently regulated depending on demand. After that, his cross rate is gradually decreasing, which is also affected by political uncertainty. The government plans to start accepting payment for energy only in rubles. And this means only one thing - a course towards the development of a commodity economy. Fortunately, this is not a default. What is it? In simple words, this is an economic maneuver consisting of several components.
Firstly, the depreciation of the ruble leads to an increase in all other currencies. Russia's assets are now almost 45% made up of dollars. This currency, as you know, is not provided with gold, but is accepted by other countries as a reserve after abandoning the "Gold Standard". Russian rubles are also in the foreign exchange reserves of other states. Devaluation allows you to purchase most of the world's ruble assets for existing dollar assets in the state’s gold and foreign currency reserves and return them to Russia.
As a result, settlements for oil and gas will require buyers to first buy rubles for their currency, and then return them back as payment. The main thing is that the ruble exchange rate will be high due to significant demand for it. Such is the long-term forecast, and this is what threatens the devaluation of the ruble in the long run. But in the short term, it can still lead to another default.
What to do to the population
Everything that threatens the devaluation of the ruble cannot have a strong impact on the commodity economy. The terrible consequence is only default, which is possible with a strong and fairly rapid devaluation. It is important for the population during this period to refuse to receive loans. Foreign exchange savings will leave the standard of living as it is now. However, it should be understood that the crisis may drag on for 5 years or more.
In this situation, the most competent tactic is to save your most important assets: real estate and cars. Buying real estate or land in promising areas for construction will significantly increase capital. The rest is important to live on the available means, for which sufficient wages are provided. And when a default occurs, the population will not be affected either, unless, of course, it holds federal loan bonds. The difference between default and devaluation is that when the conditions for default appear, the state will refuse to repay them. Otherwise, both default and devaluation do not affect the interests of the population, who do not use currency and imported goods, until the inflation rate accelerates.