To find the difference between
and depreciation of a currency, let's start with how they are alike. Both
appreciation and depreciation measure the value of one or more currencies against one or
more other currencies.
The value of things can rise or
fall. A rise in value is called appreciation. An example of
appreciation in the value of something is how a Rembrandt oil painting is worth more and
more every decade (or even every year).
A fall in value is
called depreciation. An example of depreciation in the
value of something is how your 2015 Toyota Camry Hybrid ceases to be worth $29,000 once
you sign the papers and drive it off the lot (the value of new car falls as soon as the
new owner drives away with it).
To turn again to a nation's
currency, appreciation is when the currency rises in value
and depreciation is when the currency falls in value. But currency is a special case in
rising and falling value. Currency valuation (measure of currency value) must be in
comparison to another (one or more than one) nation's
currency, for example, the US currency (USD) valuation may be in comparison with British
currency (GBP).
To give an illustration of the concept of
comparison appreciation and depreciation, a Rembrandt's value is not set in comparison
to a Monet's value. A Rembrandt (and a Monet) have intrinsic value: the value rises or
falls based upon the importance a Rembrandt (or a Monet) has in civilization. This is
different from the valuation of currency.
Because most of
the world's currency is not affixed to either a gold or silver standard measurement of
valuation (there is no gold or silver in our depositories that can be given in exchange
for every dollar held by every citizen or foreign currency investor, though there used
to be). The world's currencies are on a floating exchange rate system, meaning that
currencies develop value, or have value affixed to them, in comparison to other
currencies.
To illustrate this concept, imagine that Japan
is having steep inflation and its economy and currency are
indicating the purchasing power is less than it would be without inflation. Imagine that
for import/export transactions and currency trading transactions, buyers and sellers (of
import/export goods or of different nations' currencies) need to know what different
currencies are worth in order to fairly complete transactions between nations with
unlike currencies.
Now imagine that the United Kingdom's
currency is strong and that they have a strong gross national product (GNP). If Japan
and the UK had currencies with the same purchasing power, they could accept parity in
valuation and make straight-across transactions. But when one currency is weaker (or
stronger, depending on which side of the transaction you are looking at), then the
weaker currency must be revalued to get an accurate trading value. In this hypothetical
example, Japan's currency would be devaluated, or
depreciated, in comparison to the UK's currency in order to
facilitate fair buying and selling transactions.
works the same way but in the opposite direction. If a low value currency has an
increased capital inflow or an increased GNP, then that country's currency will become
with an increased purchasing power, and will be upwardly revaluated, or
appreciated, in comparison to the currencies of their
trading partner countries in order to facilitate fair buying and selling
transactions.
If currencies were on a gold or silver
standard, then the appreciation and depreciation of currencies would depend upon the
rising or falling price of gold as it became more or less scarce, but in a currency
market based upon a floating exchange rate system (not fixed to a standard of valuation
measurement), the valuation comparison is between the currencies of different countries,
and the valuations of countries' currencies can vary depending upon how well or badly
the country's economy is doing in terms of factors such as inflation, cash inflows,
trade deficits, general economic fundamentals, political stability, general investment
risk aversion and interest rates.
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