4 reasons why money is depreciating.

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Coinmonks

10 min readMay 26, 2022

Why is money depreciating?

Why is the purchasing power of the money we hold declining? Have we been doing something wrong? Why do we need to hold over 1.5x of the money we have to afford what we have always been able to purchase?

First, we need to understand what it means for money to depreciate, what causes money to decline, and what happens when money depreciates

TABLE OF CONTENTS

- What does depreciating money mean?

- What causes money to depreciate?

- What happens when money depreciates?

- Is depreciation good for a business?

In the previous article, we discussed why money is valuable? Where we got to understand the primary factors behind the value of money. If you have not read it and would love to, kindly read it here; https://medium.com/coinmonks/why-is-money-valuable-at-all-89ca658dd080

This brings us back to the topic, why is money depreciating?
From the previous article, we read that demand and supply are why money is valuable. These also are behind the depreciating value of money. Also, inflation and the nation’s policy can be factors behind the depreciating value of money.

WHAT DOES DEPRECIATING MONEY MEANS?

Money, as we know, is any item which is generally accepted for the exchange of goods and services and can also be used for settling debts, paying bills etc. This places value on money due to the utilities that money is used for. At some point, the value of the item/currency will be affected due to some factors or circumstances, making the currency’s value depreciate or appreciate. When the value drops, it means that the purchasing power of the money has reduced, and more of that money will be required to cater for the same amount or type of utility. For example, to exchange the currency of country A for the currency of country B, one will need to have a 1:1 ratio for exchange. When the value of the currency of country B depreciates — this ratio changes against country B, say the ratio becomes 2:1. This means that the value of that money in country B has been reduced by half.

According to in2013dollars.com, over 100 years, from 1922 to 2022. The value of $100 in 1922 is now worth $1,720.89; here, there is a $1,620.89 increase which means the dollar has lost 94% of its value. Also, considering the value of £100 in 1922, which is now worth £6,054.65, the British pound has lost 98% of its value.

What are the causes of the decline in the value of these currencies?

WHAT CAUSES DEPRECIATION?

Some factors cause depreciation; this may be a government-induced depreciation or economic activities done in the country.

Below we highlight the factors why money is depreciating.

1) Quantitative Easing (QE): Quantitative Easing (QE), in layman’s terms, is the central bank releasing money/cash to the general public.

- How do they do that?

- How does it affect the economy?

The Central bank buys financial assets like government bonds and other securities. It achieves this process of purchasing the securities by printing the money. When the Central bank purchases these securities, it gives out money to the government and corporations selling these securities, which is utilised in the economy by the selling party. This automatically decreases interest rates, so local businesses and individuals are encouraged to borrow money/source for the funds, which adds money/cash to the nation’s supply. The Central Bank owns treasury securities and mortgage-backed securities, so the Central bank buys or swaps the printed money for the treasuries. At the same time, this provides cash to local banks to give out loans and encourages people to take loans since the interest rates have declined.

How does it affect the economy?

Quantitative easing aims to boost the nation’s economy; people are encouraged to borrow and fund their businesses by decreasing interest rates. Through all the activities involved in the business sector, the nation’s economy is improved if done well. We can have higher exports than imports. We can have more manufacturing companies, and the country’s research and development industry will be enhanced.
However, while the primary intent of quantitative easing is to boost the nation’s economy, it often leads to chaos; this is because the proper supply of money must be calculated. If the calculation is short of the expected value, the purpose of the quantitative easing is not achieved. Also, suppose the money supply is more than needed; too much money is in circulation. If the supply of money exceeds its demand, this will lead to the depreciation of the currency’s value, and the economy’s condition may deteriorate.
Over the past few years, countries like the United States, the United Kingdom, and Switzerland have carried out quantitative easing as a part of their monetary policies against the financial crisis faced by them, it may have helped boost the economy, but in the long run, it brings inflation, one which happens at a slow rate.
According to investopedia.com, Quantitative Easing means; “is a form of unconventional monetary policy in which the central bank purchases longer-term securities from the open market to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy and lowers interest rates by bidding up fixed-income securities. It also expands the central bank’s balance sheet.”

2) Inflation: This is an economic situation in which the prices of goods and services increase over time. For easy comprehension, here’s an example, if a grocery bag costs $100 in 2015, the same pack now costs $157.20 in 2022. There is a 57.2% increase in the price of that one bag; now, we can say inflation affected the price of the bag. In a well-structured meaning, inflation is the general increase in the price of goods and services due to the fall and rise in the value of money. Several factors can cause inflation, but we will discuss two of these factors. The first is when the total demand for a product exceeds the supply, resulting from too many currencies chasing the product. When the supply of money in a nation is increased, this gives rise to more demands for a product or service until the supply can not satisfy the demand being received. Thus inflation occurs; this type of inflation is called; Demand-pull inflation. And also, when the cost of production is increased, the cost of wages, cost of raw materials, and cost of labour, when there is an increase in the price of all these mentioned, inflation occurs; this type of inflation is called; Cost-push inflation, thus the purchasing power (value) of the currency is decreased.

3) A surge in imports: The import and export activities have a lot to do with the value of a currency; when country A imports a product, it buys from country B from whom they are importing, which we can say the exporting country gets more prosperous, we can say that the exporting country gains some currency or a foreign currency. This automatically makes the importing country contribute to the other country’s economy in question. With this simple explanation, we can agree that the only way a nation’s economy can be improved is when their export is more than its imports. Take, for instance, when the rates at which a country, country A, is importing from another country B. It means that the country contributes financial capacity to country B, when Country A is not exporting enough to country B or any other country to counter the import increase. It means the rate at which country A contributes to the other countries through its imports is more than the contribution or gain it receives from the other countries, making their trading activities unfavourable to the economy. When the trade balance occurs, the country with more imports and lesser exports will have to balance the trades with other countries; through this, the value of their currency becomes depreciated.

4) When the Central banks reduce interest rates, this goes along with point number one. When Central banks lower interest rates, while the people in the nation are encouraged to borrow, it tends to repel foreign investments because the low-interest rates mean that the investors are receiving a lower interest in investing in the country’s assets. Thus the value of the nation’s currency is depreciated due to the diminishing foreign direct investment in the country.

Let us look at some of the terms we read above; shares, stocks, bonds, treasury, and the meaning of securities regarding assets.

Share:- A share is a unit of a stock of a company’s ownership; it is the smallest unit, the smallest part, a minute percentage of a company’s ownership.

Stock: Stock is the total units of a company’s ownership. It encompasses the total shares the equity of a company can be divided. It is also a fractional (but not small or minute) unit of the entire company’s shares.

Bond: A bond is a form of security in which the bond issuer (principal) owes the holder (holder) a debt, and is obliged to pay it back at the maturity, usually with interest based on the terms agreed.

Security: In finance, security is a tradeable asset. It can be shares, stocks and also bonds.

Treasury: This is the fund, revenue, and financial wealth of a nation or a state.

WHAT HAPPENS WHEN MONEY DEPRECIATES?

Having established the reasons why money depreciates. It is important to explore the impact currency depreciation has on the economy. The impact of the decline in the value of a nation’s currency is summarised below;

1) High Cost of Importation.: Due to the decrease in the value of a nation’s currency. The cost of importing goods and products into the country will become higher than the regular rate. This spike in price is because the ratio of the rates at which the imports occur has risen dramatically, to the extent that the imports have created more supply in the country than demand for it. Also, the exchange rates have changed. The importing country will pay more to balance the trade or rate ratio to keep the exchange at a favourable rate.

2) Hyperinflation occurs: While inflation can cause a decline in the value of the nation’s currency, if not appropriately managed, further inflation occurs, and hyperinflation sets in the nation’s economy. This makes the country’s buying power decline considerably and causes an economic meltdown. Because the buying power has depreciated, the cost of imported equipment increases significantly over time. This causes an impact on what production takes place in the country and reduces the production, causing the supply of products in the country to decrease. When this happens, the supply will not be able to balance with the demand. Because of this, resources become limited and expensive.

3) Unemployment: The impact of money depreciation forces businesses to reduce their production cost, labour, and wages. When these happen, the number of people laid off will skyrocket because these businesses cannot cope with wages and labour costs. Foreign investment tends to decline in the country, and this causes a high rate of unemployment in the country.

4) Exports become cheaper: One upside to the depreciation of money is that it encourages exportation. This is because the cost of exports will be more affordable. People or organisations from other countries will also be encouraged to import from this country as the price of goods, products, and services becomes cheaper in countries with high purchasing power. This is an upside because when there is a focus on the exportation done in the country, it can help improve the currency’s value and stabilise the economy.

This can be done using a detailed and planned strategy. While the cost of production in the country increases, there may be subsidies and support from the government in some activities done in the country. Activities like agriculture can help improve the value of the currency, where the necessary support from the government can foster an increase in the production of the agricultural produce. This agricultural produce can then be exported from the country.

IS DEPRECIATION GOOD FOR BUSINESSES?

As established earlier, depreciation leads to a decline in the nation’s economy. However, the question is, how does it affect businesses and to what extent?

Generally, when the value of a currency depreciates, the local businesses tend to either go bankrupt or reduce their labour cost. However, firms or companies that deal in exportation in the country tend to have a favourable turnover because the exports in the country are encouraged through various incentives by the government. The benefits it brings to the nation are numerous. From these activities, the government can realise some revenue from the tax on exportation and the revenue from the agricultural activities.

Depreciation of a nation’s currency is generally seen as an unfavourable economic condition to happen to a nation. Nevertheless, it can be used as a tool for correcting increasing imports done in a country, significantly when the rates of importation are growing higher than the exportation. And over time, when a country depreciates its currency without a planned strategy. It is often hard to go back to the previous value.

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4 reasons why money is depreciating.

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Written by Samuel Adeyemo