What is devaluation and how does it affect?
The term devaluation is used in a scheme where the government fixes the exchange rate. In this system, the monetary authority establishes a level for the exchange rate, and commits itself, intervening in the market by buying or selling foreign currency, to guarantee that this exchange rate remains at that level.
Until December 1994, a fixed exchange rate was used in Mexico, for which the term devaluation was used, which is associated with periods of crisis that may have been marked in the subconscious of people who refer to the exchange issue.
What is depreciation?
The term depreciation is used in a free floating exchange rate scheme, where it is determined by the interaction of supply and demand in the market, without the intervention of the authorities, such as the one currently prevailing in the country.
Starting in 1994, when the exchange rate began to float freely, depreciation or its opposite, appreciation, is an everyday thing, as the market moves freely at all times. This is why the term that should be used when talking about the exchange rate in Mexico is “depreciation”.
With a flexible exchange rate regime, any country can enjoy monetary independence, defined as the ability to conduct monetary policy for internal purposes, without external monetary influences, according to Manuel Sánchez González, former deputy governor of the Bank of Mexico and author of the book: Economía Mexican for the Disenchanted.
Monetary independence allows the central bank to pursue its statutory objectives, such as price stability. This advantage helps explain why, in recent decades, most economies have opted for flexible exchange rate regimes, Sánchez also points out.
In the last year, the peso appreciated 4.3% against the dollar. This evolution is distinctive because it occurred in the midst of a general financial collapse, which involved the decline in the exchange rate of the main currencies in the world.
In the twenty-eight years that the Mexican currency has operated under a free-floating regime, the exchange rate of the dollar in terms of pesos has fluctuated around an upward trend. In other words, regardless of the greater or lesser volatility, the peso has maintained a depreciation trend. This is how the price of the dollar in terms of pesos went from 5.00 at the end of 1994 to 19.65 at the beginning of November 2022.
Finally, it is worth mentioning that, both in economics and accounting, the term depreciation also refers to a periodic decrease in the value of assets (the capital invested by a company). Therefore, the overall value of each asset decreases with time and use.