Original author: Tyler Durden

Original translation: Block unicorn

Currency depreciation

Depreciation refers to the act or process of reducing the quality or value of something. When discussing legal tender, depreciation historically referred to the practice of reducing the precious metal content in coins while maintaining the nominal value, thereby diluting the intrinsic value of the coins. In a modern context, depreciation has evolved to refer to the decrease in the value or purchasing power of a currency—such as when the central bank increases the money supply, thereby reducing the nominal value of each unit.

Understanding depreciation

Before the appearance of paper money and coins made of inexpensive metals like nickel, currency was composed of coins made of precious metals such as gold and silver. These were the most popular metals at the time, with values that exceeded government decrees. Depreciation was a common practice aimed at saving precious metals by mixing them with lower-value metals.

This practice of mixing precious metals with lower-quality metals meant that authorities could produce more coins with the same face value at a fraction of the cost compared to coins with higher gold and silver content.

Today, coins and paper money have no intrinsic value; they are merely tokens representing value. This means that depreciation depends on supply: how much currency or paper money issuing authorities allow to circulate. Over time, depreciation has also undergone different processes and methods. Therefore, we can define old and new methods.

Traditional methods

Before the appearance of paper money, the most common depreciation processes for coins were clipping, shaving, and plugging. Malicious counterfeiters and authorities increasing the circulation of coins both employed these methods.

Clipping involved "shaving" the edges of coins to remove some metal. The resulting clippings, like shavings, would be collected and used to create new counterfeit coins.

Shaving involved vigorously shaking a bag of coins until the edges of the coins fell off and collected at the bottom. These clippings would then be collected and used to create new coins.

Plugging involved punching a hole in the middle of a coin and tapping the remaining portion to close the gap. Coins could also be sawed in half, with a piece of metal removed from the inside and then filled with inexpensive metal, before being fused back together. These techniques were gradually phased out with the advancement of modern coinage technology.

Modern methods

Increasing the money supply is the modern method governments use to depreciate currency. By printing more money, the government can obtain more funds for spending, but this can lead to citizen inflation. Currency depreciation can be achieved by increasing the money supply, lowering interest rates, or implementing other measures that encourage inflation; these are all "good" ways to reduce the value of currency.

Why does money depreciate?

Governments depreciate currency in order to obtain spending without further raising taxes. Depreciating currency to fund wars is an effective way to increase the money supply and allow participation in costly conflicts without affecting people's finances—at least that's how people perceive it.

Whether through traditional currency depreciation or modern printing methods, increasing the money supply can bring short-term economic benefits. However, in the long run, this can lead to inflation and financial crises. This impact is most directly felt by those in society who lack hard assets to counter currency depreciation.

Malicious actors introducing counterfeit currency into an economy can also lead to currency depreciation, but in some countries, the consequences of being caught can result in the death penalty.

"Inflation is the one form of taxation that can be imposed without legislation." —Milton Friedman

Governments can take measures to mitigate the risks associated with currency depreciation, preventing economic instability and weakness, such as controlling the money supply and interest rates within specific ranges, managing spending, and avoiding excessive borrowing.

Economic reforms that increase productivity and attract foreign investment also help maintain confidence in the currency and prevent currency depreciation.

Real-world examples

Roman Empire

The first example of currency depreciation can be traced back to around AD 60, during the reign of Emperor Nero in the Roman Empire. Nero reduced the silver content of the denarius coin from 100% to 90% during his tenure.

Emperor Vespasian and his son Titus incurred significant expenses in reconstruction projects after the civil war, such as building the Colosseum, compensating victims of the eruption of Mount Vesuvius, and the Great Fire of Rome in AD 64. The means chosen to weather the financial crisis was to reduce the silver content of the denarius from 94% to 90%.

Titus's brother and successor Domitian recognized the sufficient value of "hard currency" and the stability of a reliable money supply, so he increased the silver content of the denarius to 98%—only to reverse this decision when another war broke out. Inflation once again engulfed the entire empire.

This process continued gradually, with the silver content decreasing to only 5% over the next few centuries. As the currency continued to depreciate, the empire began to experience severe financial crises and inflation—especially in the third century AD, sometimes referred to as the "Crisis of the Third Century." During this period, from AD 235 to AD 284, Romans demanded higher wages and increased prices for the goods they sold to cope with currency depreciation. The era was characterized by political instability, external pressure from barbarian invasions, and internal issues such as economic recession and plagues.

It wasn't until Emperor Diocletian and later Constantine took various measures, including introducing new coins and implementing price controls, that the Roman economy began to stabilize. However, these events highlighted the fragility of the once-mighty Roman economic system.

Ottoman Empire

During the Ottoman Empire, the official currency unit, the akçe, was a silver coin, and the silver content decreased from 0.85 grams in the 15th century to 0.048 grams in the 19th century. Measures to reduce the intrinsic value of coinage were taken to produce more coins and increase the money supply. The new currencies, the kurush in 1688 and the lira in 1844, gradually replaced the original official currency, the akçe, due to its continuous depreciation.

Henry VIII

Under the rule of Henry VIII, England needed more money, so his Chancellor of the Exchequer began using cheaper metals like copper to lower the cost of coins, allowing for the production of more coins at a more affordable cost. By the end of his reign, the silver content of the coins had decreased from 92.5% to only 25%, in order to earn more money and fund the enormous military expenses required for the European wars of the time.

Weimar Republic

During the 1920s in the Weimar Republic, the German government printed more banknotes to fulfill its wartime and post-war financial obligations. This measure devalued the mark from about 8 marks per US dollar to 184 marks. By 1922, the mark had depreciated to 7,350 marks per US dollar, eventually collapsing in a painful hyperinflation, with the mark reaching 4.2 trillion marks per US dollar.

History serves as a profound reminder of the dangers of currency expansion. These once-mighty empires serve as cautionary tales for modern legal tender systems. As these empires expanded the money supply, causing currency depreciation, they were in many ways like the proverbial frog in boiling water. The temperature—or in this case, the speed of currency depreciation—gradually rose to the point where they did not realize the imminent danger until it was too late. Just as the frog seems unaware that it will be boiled alive if the water temperature rises slowly, these empires only fully recognized their economic vulnerability when their systems became unsustainable.

The erosion of their currency values is not just an economic issue; it is a sign of deeper systemic problems, marking the decline of the once-mighty empires.

Modern currency depreciation

The dissolution of the Bretton Woods system in the 1970s marked a pivotal moment in global economic history. Established in the mid-20th century, the Bretton Woods system loosely pegged the world's major currencies to the US dollar, which was itself backed by gold, ensuring a degree of economic stability and predictability.

However, its dissolution effectively freed money from its gold anchor. This shift gave central bank governors and politicians greater flexibility and discretion in monetary policy, allowing for more active intervention in the economy. While this newfound freedom provided tools to address short-term economic challenges, it also opened the door to abuse and gradual economic weakness.

Following this significant change, the US saw significant changes in its monetary policy and money supply. By 2023, the base money had soared to $5.6 trillion, approximately 69 times the $812 billion in 1971.

When we reflect on the present era and the significant changes in US monetary policy, it is crucial to heed these historical lessons. Continuous depreciation and uncontrolled currency expansion can only last for a period of time until the system reaches a breaking point.

Impact of depreciation

Currency depreciation may have various significant impacts on the economy, the extent of which depends on the degree of depreciation and the underlying economic conditions.

Here are some of the most impactful consequences of long-term currency depreciation.

Rise in inflation rate

The most direct and impactful effect of currency depreciation is the rise in inflation rate. As the value of the currency decreases, more units are required to purchase the same goods and services, thereby weakening the purchasing power of the currency.

Increase in interest rates

Central banks may respond to currency depreciation and rising inflation by raising interest rates, which can affect the cost of borrowing, business investment, and consumer spending patterns.

Erosion of savings value

Currency depreciation may diminish the value of savings held in the domestic currency. This is particularly detrimental to individuals with fixed income assets, such as retirees relying on pensions or interest income.

More expensive imported products

Currency depreciation may make imported products more expensive, potentially leading to higher costs for businesses and consumers reliant on foreign goods. However, it may also make exports more competitive internationally, as foreign buyers can purchase domestic goods at lower prices.

Weakening public confidence in the economy

Sustained currency depreciation may weaken public confidence in the domestic currency and the government's ability to effectively manage the economy. The loss of this trust may further exacerbate economic instability or even hyperinflation.

Solutions to depreciation

The solution to currency depreciation lies in reintroducing sound money—a currency with a supply that is not easily manipulated. While many nostalgically yearn for a return to the gold standard, which can be said to be superior to the contemporary system, it is not the ultimate solution. This is due to the centralization of gold by central banks. If we were to return to the gold standard, history could repeat itself, leading to confiscation and currency depreciation once again. In short, if a currency can be depreciated, it will be.

How Bitcoin avoids depreciation

Bitcoin provides a permanent solution to this issue. Its supply limit is 21 million, a number that is hard-coded and protected through proof-of-work mining and a decentralized network of nodes. Due to its decentralized nature, no single entity or government can control the issuance or governance of Bitcoin. Additionally, its inherent scarcity allows it to resist the inflationary pressures that traditional legal tender currencies typically face.

As a distributed system, Bitcoin users can ensure that the supply never deviates from the predetermined limit by running software that downloads and verifies the entire transaction ledger. By verifying every transaction in Bitcoin's history, the source and destination of every coin, users can be absolutely certain that the supply has not been depreciated and no unauthorized coins have been created.

Software like full Bitcoin nodes is essentially an anti-counterfeiting machine that anyone can run. It ensures the supply remains intact, that coins spent are properly authorized, and that nothing funny happens. Any Bitcoin wallet software can ensure that no one can restrict you from using your own money.

During times of economic uncertainty, or when central banks engage in large-scale money printing, investors often turn to assets like gold and Bitcoin for their value storage properties. Over time, people may come to realize that Bitcoin is not just a store of value, but also the next evolution of currency.

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