Depreciation: Its types and how to protect your money - GERCHIK & CO

Currency depreciation in layman’s terms

26-03-2020

You must have heard the expression “depreciation” many times before and wondered what it really means.

 

Depreciation is the process of deliberate downward adjustment of a country’s currency in relation to other currencies.

The following article aims to examine the types of depreciation, its causes and shed some light on how you can preserve your capital.

Contents:

1. Depreciation and What It Means
2. Causes
3. Depreciation Is No Crisis
4. How to Protect Your Money Against Depreciation

Depreciation and What It Means

To give you a rough idea, depreciation is the process whereby the currency loses its value.

There are several types of depreciation:

  • Official depreciation. The country makes a public announcement about the depreciation of the currency. In other words, economic issues become known to everybody.
  • Hidden depreciation. In essence, everything that is happening is concealed from both the country’s residents and foreign powers. The officials make no public statements about the depreciation of the currency in the hope that investors will not withdraw their capital.
  • Controlled depreciation. This is a type of depreciation where the central bank is the one that controls the decline in the price of the national currency, maintaining its value at a certain level for a certain time period.
  • Uncontrolled depreciation. This is a process whereby any country’s attempt aimed at preventing depreciation and stabilizing the currency ends up being fruitless. This depreciation type is the most common of all.

Depreciation and all you have to know about it

Causes

As mentioned previously, depreciation is basically a decline in the exchange rate of the currency. There are several reasons why this happens.

  1. Issues on the foreign economic market. Foreign trade is an essential part of the country’s economy. The greater the difference in the ratio between imports and exports, the bigger the drop in currency’s value.
  2. The unstable economic situation. Delays in salary and benefits payments, citizens’ lack of trust in banks and financial institutions, the decline in the loan and deposit system of the country.
  3. External debt. Existing foreign economic issues can result in depreciation of the national currency.
  4. Political issues. The unstable situation in the country fuels panic which, in turn, causes a capital outflow from the country.
  5. Escalation of inflation. Essentially, this is a decline in the purchasing power of the national currency within a country.
  6. Lack of gold and foreign exchange reserves. In this scenario, the national currency cannot be backed by gold and thus loses its value.

Depreciation Is No Crisis

Just like any other economic change, depreciation carries consequences that can be both positive and negative. So, if you are wondering if depreciation is the beginning of the end, let us assure you - this is not a full-blown economic crisis yet.

DOWNSIDES OF DEPRECIATION

  • decline in living standards of the citizens;
  • weakened trust and decreasing demand for the national currency;
  • further reduction in payments to the citizens;
  • drop in international investment;
  • overpricing of imported goods;
  • capital withdrawal from the country;
  • deposits and bank account closure;
  • economic instability resulting in a financial market weakening.

UPSIDES OF DEPRECIATION

  • growth in exports and thus increase in profits resulting from export;
  • gradual accumulation of gold and foreign exchange reserves;
  • increase in domestic production;
  • demand for national commodities;
  • high cash turnover.

As you can see, depreciation can sometimes be a real blessing in disguise. What’s important is to plan wisely and control the process.

How to Protect Your Money Against Depreciation

Investing in liquid commodities is one of the ways to do that. These can be precious metals, such as gold, or real estate. During depreciation, the price of household appliances and electronics will spike, which is why it makes sense to pay attention to it.

If you wish to prepare yourself for the possible depreciation, purchase the currency beforehand, and not when the prices will already be going up. Typically, banks overcharge during depreciation, and you will lose a lot of money when buying dollars or euros.

Trading in the financial markets is another way to keep your money safe and even boost your capital during the depreciation. You can profit from fluctuations in exchange rates on the foreign exchange market, and the profit made won’t depend on how “healthy” your country’s economy is.

Remember: forewarned is forearmed! Now you know what depreciation is all about and that it is not a death sentence. A surefire way to overcome panic when the national currency rate starts dropping is to invest in a business that will generate profit even in an economically unstable situation.



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