Currency Depreciation

What Is Currency Depreciation?

Currency depreciation is a fall in the value of a currency in terms of its exchange rate versus different currencies. Currency depreciation can happen due to factors like economic fundamentals, interest rate differentials, political flimsiness, or risk aversion among investors.

Grasping Currency Depreciation

Countries with weak economic fundamentals, for example, constant current account deficits and high rates of inflation, generally have deteriorating currencies. Currency depreciation, if orderly and continuous, further develops a country's export competitiveness and may further develop its trade deficit over the long run. However, an unexpected and sizable currency depreciation might scare foreign investors who fear the currency might fall further, leading them to pull portfolio investments out of the country. These activities will put further downward pressure on the currency.

Simple monetary policy and high inflation are two of the leading reasons for currency depreciation. At the point when interest rates are low, many billions of dollars pursue the highest yield. Expected interest rate differentials can trigger an episode of currency depreciation. Central banks will increase interest rates to combat inflation as too much inflation can lead to currency depreciation.

Additionally, inflation can lead to higher input costs for exports, which then makes a country's exports less competitive in the global markets. This will augment the trade deficit and influence the currency to devalue.

Quantitative Easing and the Falling USD

In response to the global financial crisis of 2007-2008, the Federal Reserve set out on three rounds of quantitative easing (QE), which sent bond yields to record lows. Following the Federal Reserve's announcement of the primary round of QE on Nov. 25, 2008, the [U.S. dollar](/usd-US dollar) (USD) started to devalue. The U.S. dollar index (USDX) fell by over 7% in the three weeks after the beginning of QE1.

In 2010, when the Fed set out on QE2 the outcome was something similar. During the 2010 to 2011 USD depreciation, the greenback hit all-time lows against the Japanese yen (JPY), the Canadian dollar (CAD), and the Australian dollar (AUD).

Political Rhetoric and Currency Depreciation

While economic fundamentals generally determine the value of a currency, political way of talking can make a currency fall too.

Somewhere in the range of 2015 and 2016, the U.S. furthermore, China were more than once in a clash of words concerning each other's currency value. In August 2015, the [People's Bank of China](/people groups bank-china-pboc) (PBOC) devalued the country's currency, the yuan, by generally 2% against the U.S. dollar. Chinese authorities said the move was required to forestall a further slide in exports.

In 2019, the Trump administration named China a currency controller, saying Chinese authorities were deliberately cheapening its currency, leading to unfair benefits on trade. In 2018, U.S.- China political manner of speaking moved in the direction of protectionism that brought about a long-term trade dispute between the world's two biggest economies.

Volatility and Currency Depreciation

Unexpected episodes of currency depreciation, especially in emerging markets, unavoidably increase the fear of "contagion," by which large numbers of these currencies get tormented by comparable investor concerns. Among the most notable was the Asian crisis of 1997 that was triggered by the collapse of the Thai baht that caused a sharp devaluation in most Southeast Asian currencies.

In another model, the currencies of nations, for example, India and Indonesia traded pointedly lower in the mid year of 2013 as concern developed that the Federal Reserve was ready to unwind its huge bond purchases. Developed market currencies can likewise experience periods of extreme volatility. On June 23, 2016, the British pound (GBP) depreciated more than 10% against the U.S. dollar after the U.K. casted a ballot to leave the European Union, alluded to as Brexit.

Illustration of Currency Depreciation

Turkey's currency, the lira, lost over 20% of its value against the USD in August 2018. A combination of factors prompted the depreciation. To start with, investors developed fearful that Turkish companies wouldn't have the option to pay back loans designated in dollars and euros as the lira kept on falling in value.

Furthermore, President Trump approved the doubling of steel and aluminum tariffs forced on Turkey when there were fears about the country's striving economy. The lira plunged pointedly after Trump delivered the news by means of a tweet.

Finally, Turkey's leader, Recep Tayyip Erdogan, didn't allow Turkey's central bank to raise interest rates, while simultaneously, the country didn't have an adequate amount of U.S. dollars to guard its currency on foreign exchange markets. Turkey's central bank finally lifted interest rates in September 2018 from 17.75% to 24% to settle its currency and curb inflation.

All the more as of late, in 2020, the lira has been fundamentally deteriorating due to geopolitical risks because of Turkey's policies in the Middle East and somewhere else. In October 2020, the Lira sank to historic lows. It dropped past 8.05 to the U.S. dollar. The lira lost 26% of its value in 2020 and over half since the finish of 2017.

Highlights

• The Federal Reserve's quantitative easing programs used to animate the economy in the aftermath of the 2007-2008 financial crisis caused U.S. dollar depreciation.
• Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
• Economic fundamentals, interest rate differentials, political insecurity, or risk aversion can cause currency depreciation.
• Currency depreciation in one country can spread to different countries.
• Orderly currency depreciation can increase a country's export activity as its products and services become less expensive to buy.