Do Depreciating Currencies Increase Debt Burdens?

| Oct 03, 2017 01:08 PM EDT

Do Depreciating Currencies Increase Debt Burdens?

The US dollar index (DXY) is currently trading at 91.91. This broad measure of the strength of the USD is a trade-weighted average of the greenback against 6 currencies. These include the SEK, CHF, CAD, JPY, GBP, and EUR. The currency with the highest weighting against the greenback is the EUR at 57.6%. Over the past 52 weeks, the DXY has a low of 91.41, and a high of 103.82. For the year to date, the US dollar index has depreciated by 10.22%, and current trends indicate that the greenback will continue on this path.

Domestic Nominal Debts Are Helped by Depreciating Currencies

The cable (USD/GBP) was last trading at 0.7522, and declined from 0.81 at the start of the year to its current level. Much the same is true of the EUR/USD pair which started the year at 1.05, and is currently trending around 1.20. The sharp depreciation of the greenback is evident with major currencies across the board, in line with the performance of the DXY. The importance of currency depreciation and household debt, and national debt cannot be understated. If the debt is owed to domestic creditors, currency depreciation in fixed USD terms improves the debt obligation because the nominal value of the debt (provided the debt repayments are not adjusted in real terms) is the same while the buying power of that USD is less.

How Are Foreign Debts Affected by Depreciating Currencies?

A devalued currency simply provides greater supply of money to pay off debt, but that money is worth significantly less than it was prior to the devaluation. Consider an exchange rate of $1: €0.75, and an exchange rate of $1 and €1. In euro terms, the depreciation of the EUR from €0.75 for every $1 to €1 for every $1 means that more euros will have to be paid for every dollar of debt. This is clearly disadvantageous to Europeans who are paying dollar-denominated debt. By the same token, Americans who have euro denominated debt will be paying significantly less for the debt burden if the USD appreciates, and vice versa.

A practical example will further clarify how international debt obligations are directly impacted by depreciating currencies. Prior to the Brexit referendum on June 23, 2016, the GBP/USD was trading around 1.48. That means that every £100,000 was worth the equivalent of $148,000. Fast-forward to the present day, and the exchange rate is approximately 1.30. This means that every £100,000 is worth just $130,000.

Debt and Interest Rates

For Americans, the impact of a depreciating currency (the GBP) on sterling-denominated debt means that less USD will be required to repay that debt. In this case, it is advantageous for Americans to have GBP-denominated debt. On the other hand, Britons with dollar-denominated debt are now in a worse situation because they have to pay more per USD in GBP terms. Depreciating currencies or devalued currencies appear similar on paper, since it means that more of that currency is required to purchase foreign currencies.

What Brought About a Debt Crisis in the US?

The more important question with debt is what caused the debt crisis in the US in the first place. There are growing concerns about the emergence of a debt problem in the US. For example, the typical American household is $134,643 in debt. This is comprised largely of automobile loans, personal loans, business loans, credit card loans, student loans, and mortgage loans. Viewed in perspective, this debt burden means that the typical American family is paying $1300 + per year in interest repayments alone. In the US today, it's not only interest rates and the value of the currency that are important, it's also the inflation rate. If the inflation rate is rising and the currency is depreciating, the real purchasing power of the currency is diminished.

Most Popular