Currency Depreciation

AAA

DEFINITION of 'Currency Depreciation'

A decrease in the level of a currency in a floating exchange rate system due to market forces. Currency depreciation can occur due to any number of reasons – economic fundamentals, interest rate differentials, political instability, risk aversion among investors and so on. Countries with weak economic fundamentals such as chronic current account deficits and high rates of inflation generally have depreciating currencies. Currency depreciation, if orderly and gradual, improves a nation’s export competitiveness and may improve its trade deficit over time. But abrupt and sizeable currency depreciation may scare foreign investors who fear the currency may fall further, and lead to them pulling portfolio investments out of the country, putting further downward pressure on the currency.

INVESTOPEDIA EXPLAINS 'Currency Depreciation'

Easy monetary policy and high inflation are two of the main causes of currency depreciation. In a low interest-rate environment, hundreds of billions of dollars chase the highest yield. Expected interest rate differentials can trigger a bout of currency depreciation.

In the 12 months ending January 2014, for example, the Canadian dollar depreciated by 10% against the U.S. dollar. This was because economists and analysts expected the Bank of Canada to relax its monetary policy in 2014, at the same time the Federal Reserve was preparing to scale back its bond purchases, which was seen as a precursor to tighter monetary policy.

Inflation can also cause currency depreciation. This is because the higher input costs for export products made in a high-inflation nation will make its exports uncompetitive in global markets, which will widen the trade deficit and cause the currency to depreciate.

Sudden bouts of currency depreciation, especially in emerging markets, inevitably raise the fear of “contagion,” whereby many of these currencies get afflicted by similar investor concerns. There have been a number of such episodes, among the most notable being the Asian crisis of 1997 that was triggered by the devaluation of the Thai baht. In the summer of 2013, the currencies of nations such as India and Indonesia traded sharply lower on concern that the Federal Reserve was poised to wind down its massive bond purchases.

RELATED TERMS
  1. Currency Risk Sharing

    A form of hedging currency risk in which the two parties to a ...
  2. Current Account Deficit

    A measurement of a country’s trade in which the value of goods ...
  3. Devaluation

    A deliberate downward adjustment to the value of a country's ...
  4. Competitive Devaluation

    A series of sudden currency depreciations that nations may resort ...
  5. Currency Appreciation

    An increase in the value of one currency in terms of another. ...
  6. Inflation

    The rate at which the general level of prices for goods and services ...
Related Articles
  1. Bonds & Fixed Income

    Coping With Inflation Risk

    Inflation is less dramatic than a crash, but it can be more devastating to your portfolio.
  2. Forex Education

    Why China's Currency Tangos With The USD

    Investopedia explains: It takes two to tango, but unless both partners move in perfect cohesion, a sequence of graceful maneuvers can be reduced to a series of clumsy moves. The latter depiction ...
  3. Forex Education

    The Hazards Of Currency Movements

    Devaluation and revaluation are official changes in the value of a nation’s currency in relation to other currencies. The terms are generally used to refer to officially sanctioned changes in ...
  4. Economics

    Interesting Facts About Imports And Exports

    Imports and exports exert a profound influence on the consumer and the economy. Learn what affects these figures, and in turn how these figures affect the economy.
  5. Investing Basics

    How To Profit From Inflation

    Inflation - defined as a sustained increase in the price of goods and services - seems to be inevitable. While rising prices are bad news for consumers, as it takes an ever-increasing amount ...
  6. Bonds & Fixed Income

    Understanding Interest Rates, Inflation And The Bond Market

    Get to know the relationships that determine a bond's price and its payout.
  7. Forex Education

    Corporate Currency Risks Explained

    Transaction, translation and economic risks can affect a company's balance sheet.
  8. Mutual Funds & ETFs

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  9. Forex Education

    How Inflation-Fighting Techniques Affect The Currency Market

    Central banks use these strategies to calm inflation, but they can also provide longer-term clues for forex traders.
  10. Forex Education

    The History Of Money: Currency Wars

    Find out how conflicts have changed the role money plays in our lives.

You May Also Like

Hot Definitions
  1. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  2. Asset Class

    A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same ...
  3. Fiat Money

    Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat ...
  4. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  5. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  6. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
Trading Center