Difference Between Devaluation & Depreciation

Depreciation and devaluation are two economic events that deal with the value of your country's currency. Both of these situations cause the value of your currency to drop versus the rest of the world. However, they have two different causes and long-term effects on your country's economy. Understanding the difference between these two events will help you better plan your portfolio for the future.

Depreciation happens in countries with a floating exchange rate. A floating exchange rate means that the global investment market determines the value of a country's currency. The exchange rate among various currencies changes every day as investors reevaluate new information. While a country's government and central bank can try to influence its exchange rate relative to other currencies, in the end it is the free market that determines the exchange rate. All major economies use a floating exchange rate. Depreciation occurs when a country's exchange rate goes down in the market. The country's money has less purchasing power in other countries because of the depreciation.

Devaluation happens in countries with a fixed exchange rate. In a fixed-rate economy, the government decides what its currency should be worth compared with that of other countries. The government pledges to buy and sell as much of its currency as needed to keep its exchange rate the same. The exchange rate can change only when the government decides to change it. If a government decides to make its currency less valuable, the change is called devaluation. Fixed exchange rates were popular before the Great Depression but have largely been abandoned for the more flexible floating rates. China was the last major economy to openly use a fixed exchange rate. It switched to a floating system in 2005.

The immediate impact of depreciation and devaluation on property is pretty similar. Most of your property, like your home and your car, won't change in value as they are based only on your country's currency. However, if you're planning to sell your assets and move out of the country, you're in a bad spot. The drop in your currency's value means you'll get less money abroad then you would have before the drop. This change will also make your housing market more attractive to foreigners. Depreciation and devaluation make it cheaper for foreigners to buy your local real estate. You should see an increase in foreign buyers after this currency change.

The short-term impact on devaluation and depreciation on your investments will also be pretty similar. These events are good for companies that sell domestically and export to other countries, so their share prices should increase. A drop in your exchange rate makes it more expensive for people to buy goods from other countries, however. They'll end up buying more from domestic companies. On the flip side, the drop in your currency's value makes it cheaper for other countries to buy goods from your country. Depreciation and devaluation are bad for companies that buy goods or raw materials from abroad. The drop in your currency will make it more expensive for imports. These companies will see a loss in income and a drop in their share prices.

While depreciation and devaluation have the same immediate impact, they have different long-term effects. A drop in your currency's value generally improves your country's economy as people spend more domestically and countries buy more of your exports. In a floating economy that faces depreciation, this spending boost will make the country look better for investors. They'll want to buy more of the currency and push its value back up, canceling out some if not all the depreciation. This can't happen in a fixed-rate economy as only the government can change rates. While this can keep a boom going longer, it also increases the risk of inflation as the government must keep printing money to keep its exchange rate from rising.