Currency appreciation is an increase in the value of one currency in relation to another. This means one can buy more units of the other than before. Appreciation is always relative to other assets and currencies.
For example, suppose the U.S. dollar (USD) / euro (EUR) exchange rate changed from 0.92 to 0.95; that would mean the USD appreciated against the EUR by 3.26%. In this case, $100 USD went from being worth 92 EUR to 95 EUR, which would be good news for people or companies needing to exchange USD for EUR and bad news for those wanting to do the opposite.
Currencies appreciate against each other for various reasons, including changes in governments’ monetary and fiscal policies, interest rates, trade balances, and business cycles.
Key Takeaways
- Currency appreciation refers to the increase in value of one currency relative to another in forex markets.
- It’s the opposite of currency depreciation, which occurs when a currency loses value compared to the currency against which it is being traded.
- The value of currencies isn’t absolute but always relative to other currencies and assets.
- Countries use currency appreciation as a strategic tool to boost their economic prospects.
How Currency Appreciation Works
In a floating rate exchange system, the value of a currency constantly changes based on supply and demand in the forex market. The fluctuation in values allows traders and firms to increase or decrease their holdings and profit from them.
Currency appreciation, however, is different from increases in securities prices. Currencies are traded in pairs. Thus, a currency appreciates when its value goes up compared to its pair. When a stock appreciates in price, this is often based on the market’s assessment of its intrinsic value, though many technical traders think that market prices are indeed relative only to one another, not some value outside the market.
Typically, a forex trader trades a currency pair in the hopes of appreciation of the base currency against the counter currency. Forex traders used to be representatives of large multinationals, hedge funds, and other significant players in the currency markets. However, the internet has changed that considerably in the last two decades, with individual investors far more involved in trading currencies to net gains. While commercial and investment banks still do most of the currency trading in the forex markets, there’s far more trading among professional and individual investors.
This means there’s a broader swath of people—not just travelers heading overseas soon—outside of central banks and major currency institutions watching as currencies appreciate against one another. As with other parts of economics, their value is driven by supply and demand. If the value appreciates (or goes up), demand for the currency also rises. In contrast, if a currency depreciates, it loses value compared to the currency against which it is being traded.
Understanding Currency Appreciation
Standard currency quotes list two currencies. For example, you might see USD/JPY = 149.2. The first of the two currencies (USD) is the base currency and represents a single unit, or 1.0 in the fraction 1.0/149.2. The second is the quoted currency and is represented by the rate as the amount of that currency needed to equal one unit of the base currency. This quote thus reads: “One U.S. dollar buys 149.2 units of Japanese yen.”
For the purposes of currency appreciation, the rate directly corresponds to the base currency. If the rate increases to 160, then one U.S. dollar now buys 160 units of Japanese yen and thus appreciates. As a rule, the increase or decrease of a rate always corresponds to the appreciation/depreciation of the base currency, and the inverse corresponds to the quoted currency.
The U.S. dollar is the most traded the world over, accounting for one side in almost nine out of every 10 trades. The most popular currency pairs to trade are EUR/USD, USD/JPY, GBP/USD, and USD/CHF.
Appreciation of Currencies vs. Stocks
A stock is a security that represents ownership in a corporation. By contrast, a currency represents the economy of a country, and a currency rate is quoted by pairing two countries together and calculating an exchange rate of one currency relative to the other. Consequently, the underlying economic factors of the representative countries have an effect on that rate.
An economy experiencing growth should result in a currency appreciating, and the exchange rate should adjust accordingly. The country with the weakening economy may experience currency depreciation, which also has an effect on the exchange rate.
$8.2 trillion
Daily trading in currencies dwarfs any other market, including equities. More than $8.2 trillion in currency is exchanged in the forex markets each day.
Effects of Currency Appreciation
When a nation’s currency appreciates, it can have many different effects on the economy. Here are just a couple:
- Export costs rise: If the U.S. dollar appreciates, foreigners will find American goods more expensive because they have to spend more for those goods in USD. That means that with the higher price, the number of U.S. goods being exported will likely drop. This eventually leads to a reduction in gross domestic product (GDP), which is definitely not a benefit.
- Cheaper imports: If American goods become more expensive on the foreign market, foreign goods, or imports, will become cheaper in the U.S. One U.S. dollar will go further, meaning you can buy more goods imported from abroad. That means Americans benefit from lower prices, leading to lower overall inflation.
Currency rates are thus subject to the ebb and flow, or appreciation and depreciation, corresponding to the economic and business cycles of their underlying economies.
Ranked 22th
Despite the extensive media coverage of Bitcoin and other cryptocurrencies, their trading volume represents a mere blip in the global currency markets. If we compute the average daily trading value of all cryptocurrencies for the year leading up to August 2024 and compare that with the list of most traded national currencies, as reported by the Bank for International Settlements, the entire cryptocurrency market would rank alongside the Polish złoty and Danish krone in terms of daily trading volume, or less than 0.75% of forex trading. This puts into perspective the scale of cryptocurrency trading relative to the regular forex markets.
Real-World Example of Currency Appreciation
The USD/JPY currency pair has experienced significant fluctuations since 1990. In the early 1990s, the pair was relatively stable, with the yen strengthening against the dollar because of Japan’s robust economic performance. But soon, “Japan’s lost decade” arrived. By the mid-1990s, the yen had appreciated sharply, reaching a high of around 80 yen per dollar in 1995. This appreciation was driven by Japan’s large trade surpluses and the perception of the yen as a safe-haven currency during periods of global economic uncertainty.
The Asian financial crisis of 1997-1998 initially led to a stronger dollar, but this was followed by a rapid yen appreciation as Japanese investors repatriated overseas investments. In 1998, the pair reached a low of around 145 yen per dollar. The dot-com bubble and its burst in the early 2000s, coupled with Japan’s continued economic struggles and the U.S. Federal Reserve’s monetary policies, caused the pair to fluctuate wildly, generally trending toward a weaker yen through the mid-2000s.
The global financial crisis of 2008 marked another turning point for USD/JPY. Initially, the yen strengthened significantly as a safe-haven currency, reaching as high as 75.55 yen per dollar in 2011—a post-World War II high. This strength, though, prompted intervention from the Bank of Japan, which argued it was snuffing out the country’s ability to compete with its exports.
Since then, the pair has been shaped by divergent monetary policies: the U.S. Federal Reserve’s quantitative easing, followed by gradual tightening, contrasted with the Bank of Japan’s persistent ultraloose monetary policy to combat deflation. The Bank of Japan has maintained a policy of very low or even negative interest rates for much of this period. This has often led to a weaker yen as investors sought higher returns in other currencies, including the U.S. dollar.
Conversely, when the U.S. Federal Reserve has raised interest rates, the dollar has typically strengthened against the yen. In addition, the USD/JPY pair has shown a close correlation with U.S. Treasury yields: higher yields tend to attract investment into dollar-denominated assets, boosting the dollar relative to the yen.
In 2020, the COVID-19 pandemic initially caused a flight to safety, strengthening the yen as investors sought refuge from market volatility. However, as the global economy began to recover and the U.S. Federal Reserve tightened its monetary policy, the dollar gained strength against the yen.
By the summer of 2024, the USD had appreciated against the JPY to levels not seen since before 1990—a result of higher interest rates in the U.S. as the Bank of Japan pushed for a looser yen over the previous couple of years. Once it hit that summer’s high, the U.S. began seeing signals of a potential recession—spurring the U.S. Federal Reserve to look at cutting interest rates—while the Bank of Japan was starting to heed calls to deal with inflationary signs in the country. These moves would reverse the policies of both countries in recent years, which should mean the yen will appreciate against the dollar.
Is Currency Appreciation Good or Bad?
Currency appreciation can be good or bad depending on individual circumstances. For example, appreciation would likely benefit the forex trader who went “long” the currency in a trade, as well as importers, who would suddenly see the money in their local currency become worth more and capable of buying more goods from abroad. Those on the wrong side of a forex trade or, for instance, exporters could see their finances worsen.
What Is the Difference Between Appreciation and Depreciation?
Appreciation describes the rise in value of an asset. Depreciation means the opposite. When something depreciates, it loses value.
What Is the Disadvantage of Appreciating Currency?
Common disadvantages of an appreciating currency include reducing export demand, increasing trade deficits, and making it more expensive for foreigners to invest in the country.
What Is the Strongest Currency in the World?
The Kuwaiti dinar is the strongest currency in the world. As of August 2024, one U.S. dollar buys you 0.306 Kuwaiti dinars.
The Bottom Line
Currencies trade in pairs and, in most cases, float in value. They can rise (appreciate) and fall (depreciate) in value against one another, which is something forex traders seek to make money off. Appreciation occurs when demand for the currency rises.
While currency appreciation can benefit consumers by making imported goods cheaper and potentially reducing inflation, it can pose challenges for exporters by making their products more expensive in foreign markets. For investors, currency appreciation can significantly impact returns on foreign investments and influence investment strategies.
Central banks closely monitor currency movements, sometimes intervening in foreign exchange markets to manage appreciation or depreciation rates. The interchange between currency appreciation, trade balances, inflation rates, and economic growth is a significant part of the ebb and flow of international trade and economics. As such, a thorough understanding of currency appreciation is crucial for navigating the complexities of global finance in an interconnected world where no currency has a value unto itself but only in relation to others.
