In a global economy, events in one nation may have a worldwide impact.
That’s why most nations try to maintain an equilibrium in foreign economic conditions to encourage trade and investment.
Governments sometimes employ “currency devaluation” as a way to achieve such a balance.
- What exactly is currency devaluation, and why does it happen?
- What are the benefits and drawbacks of currency devaluation for a country’s economy?
- Is there any negative impact in the first place?
And, if so, how can investors protect themselves against them? What role does cryptocurrency play in currency depreciation?
In this post we’ll dive in.
A Short History on Currency Devaluation
Many nations currencies previously adhered to a so-called “gold standard.” The US dollar was backed by gold, as were other currencies.
There was restricted convertibility of dollars into gold. An ounce of this valuable metal was worth $20.67 at the start of the 20th century.
As a result of the United States being removed from the standard, the price was changed to $35 per ounce in the middle of the 1930s decade.
The gold standard was officially abandoned during the administration of Richard Nixon (1969-1974).
As a result, the price of gold skyrocketed.
One of the major economic consequences was that global currencies could go wherever they wanted in relation to one another.
They were no longer bound by any standards. This change opened the door for governments to make currency exchange rates more convenient as they saw fit.
Currency devaluation, or deliberate reductions in the value of a country’s money, is one such adjustment.
Why Some Governments Prefer Currency Devaluation?
Contrary to popular belief, a strong currency is not always the best solution for a country’s economy.
Because foreign goods and services would be more costly, a country with a powerful currency might have difficulties enticing international investment.
The purchasing power of the local population would be greater abroad, but this would not make the nation more competitive economically.
However, if foreign investors perceive the country to be cost-effective for conducting business, capital would flow into the nation’s economy.
The end result would be more employment, greater exports, and broad economic development.
So Does Currency Devaluation Have Bad Effects On The Economy?
Although devaluation of currency might be beneficial to a nation’s economy, it may also have some negative consequences.
Inflation is the most frequent negative consequence of currency depreciation. Imported items become more costly as a country’s currency decreases in value.
As a result, end consumers would boost the desire for locally produced products and services.
However, if the supply of local producers can’t keep up with rising demand, the costs of local items and services will rise as well.
Furthermore, the country’s currency devaluation damages its image.
While devaluation draws in international investment, it also raises concerns about a nation’s economic strength.
If a country’s currency is continuously depreciated, foreign investors may lose faith in the economy and its ability to achieve genuine economic development.
Borrowing in a foreign currency, on the other hand, may expose borrowers to losses should their payments be converted into a devaluing currency. Finally, the result could be the exact opposite of what was intended.
The “Safe” Traditional Hedges against Currency Devaluation
Currency devaluation generates uncertainty for all investors, as it might affect their assets in the future.
As a result, investors have used various assets and commodities over time to protect their investments from inflation.
Which hedges have delivered the best results?
The table below summarizes some of the most effective defensive strategies.
- Precious metals: Throughout economic crises, gold and silver have always retained their value. These commodities are regarded as some of the most effective Inflation hedges. As a result, investors usually keep actual reserves of precious metals in bars of bullion coins.
- ETFs, or exchange-traded funds (ETFs): These are a popular method of investing in precious metals. Because keeping a large amount of bullion coins is not feasible, many investors choose ETFs. Gold and silver are represented by ETFs. The fund itself keeps real metals; the investors instead receive derivative contracts linked to silver or gold. It is always more convenient to store paper than metal bars at home.
- Commodities: These are an excellent way to protect your assets against inflation. One of the most efficient methods to hedge investments against inflation is through the use of commodities. Metals, oil, and energy are examples of common hedges. Because these products’ prices typically rise alongside consumer price indices, they provide a safeguard for the value of financial assets. These commodities are bought as contracts, options, or through ETFs.
- Real estate: Land and property are tangible assets that tend to retain their worth during inflation. Furthermore, these items may appreciate in value over time and offer returns to the investor. Renting or leasing your real estate might create extra money for you.
New Kid On The Block: Cryptocurrency as a New Hedge against Currency Devaluation
A new form of asset, cryptocurrency, was introduced with the release of Bitcoin in 2009.
Bitcoin and other cryptocurrencies have been gaining acceptance as a hedge against currency devaluation’s deadly consequences over the last several years.
Because of its ability to store value, Bitcoin is frequently dubbed the “digital gold.”
Because there can only be a maximum amount of 21 million digital coins in circulation, the price of Bitcoin will only rise as all of them are mined.
Furthermore, Bitcoin has a high liquidity.
It can be readily sold on a variety of exchanges that are accessible 24 hours a day, 7 days a week.
Furthermore, the number of online and physical businesses that accept Bitcoin is rising every day.
Other cryptocurrencies such as Ethereum are also used as inflation hedges.
One of the most effective ways to safeguard your cryptocurrency investment is to diversify your crypto portfolio.
You can diversify by using an exchange like Binance or Coinbase to buy crypto assets.
These exchanges lists several digital coins and tokens. They allow you to purchase and sell cryptocurrencies without having to worry about any liquidity issues.
Can Cryptocurrencies Really Be A Safe Hedge?
Cryptocurrencies have proved to be effective hedges against inflation and other negative consequences of currency depreciation.
To be on the safe side, they should be used in conjunction with conventional hedges.
In the end, there is no such thing as a perfect hedge against devaluation and its drawbacks.
Cryptocurrencies are still in their early stages. Despite the fact that the cryptocurrency market is exciting and developing rapidly, cryptocurrencies are extremely volatile and unpredictable at this point.
As a result, you should do your homework before investing in any digital currency.