depreciation

Imagine a year ago your British pound bought 1.40 US dollars, and now the very same pound buys only 1.20. You have not become poorer at home — your wages and prices in Britain are unchanged — but the moment you cross a border, your money buys less. That fall in a currency's market value against another currency is depreciation. The currency has 'weakened'; it now buys fewer foreign goods, foreign holidays and foreign assets.

Under a floating exchange rate, depreciation happens when more people want to sell a currency than to buy it — supply outweighs demand. Reasons include investors pulling money out, lower interest rates that make the currency less attractive to hold, or weaker exports. If the pound slides from 1.40 to 1.20 dollars, that is roughly a 14 percent fall: British imports and overseas travel get about that much dearer, while British exports look cheaper to foreigners. Note the vocabulary split: a market fall under floating is depreciation, while a deliberate official cut to a fixed rate is devaluation — same direction, different mechanism.

Depreciation, like its opposite, cuts both ways. It can be a relief valve: a cheaper currency makes a country's exports more competitive and can help close a trade gap, which is why struggling economies sometimes welcome a fall. But it makes imported food, fuel and medicine more expensive, feeding domestic inflation, and it raises the local-currency cost of any debt owed in foreign money — a dangerous combination for countries that borrow in dollars. So a 'falling' currency is neither simply bad nor good; it redistributes pain and gain across exporters, importers, savers and borrowers.