A dollar devaluation occurs when the dollar's purchasing power goes down. Although a dollar will remain a dollar, it will buy less. This can eventually be felt through increased prices for energy or food, or through reduced currency exchange rates, making travel abroad or the purchase of imported products more expensive. A dollar devaluation typically leads to inflation and, through that, higher interest rates.
Broader Economic Effects
Devaluation means the dollar buys less. This can cause inflation, especially on items such as energy and food. It also causes a reduction of the value of the dollar relative to other currencies, making international travel and imports more expensive. On the other hand, it also makes U.S. exports cheaper in the world market. In addition, the inflation that a devalued dollar brings typically also causes wages to increase, helping to blunt some of the impact of inflation. On the whole, though, inflation and the uncertainty that it brings are bad for an economy.
Effects on Fixed-Rate Mortgage and Credit Card Debt
If you have fixed-rate debt, a dollar devaluation will have no impact on your payments. Your mortgage payment will not change. In fact, you might come out ahead if the devaluation leads to inflation. For instance, if you have a $1,000 fixed-rate mortgage and $4,000 a month in income, you are paying 25 percent of your income for housing. If a dollar devaluation leads to 15 percent inflation, your income should go up to $4,600, but your mortgage payment will not change, reducing your housing cost to 21.7 percent of your income. In addition, your house's value will go up while your loan balance remains the same, creating equity.
Effects on Adjustable-Rate Mortgage and Credit Card Debt
Adjustable rates do move in the event of inflation caused by a dollar devaluation. Generally speaking, lenders want to get a return above the rate of inflation. As such, if the dollar gets devalued and the inflation rate spikes, you can expect interest rates on adjustable debts to adjust up to maintain a spread in which the rate on the loan is above the inflation rate.
Effects on New Mortgage and Credit Card Debt
A dollar devaluation will make new mortgages and credit cards more expensive and more difficult to get. As the dollar loses value, inflation will increase, requiring interest rates to go up. In addition, because the risk of lending money goes up due to high inflation, lenders will frequently tighten lending standards, making it harder for you to get a mortgage or new credit card.
- Federal Reserve Bank of New York: Currency Devaluation and Revaluation
- Forbes: Cue The Helicopters, Dollar Devaluation Is Here; Frank Beck; March 2009
- "The Wall Street Journal"; Get Ready for Inflation and Higher Interest Rates; Arthur Laffer; June 2009
- PBS Newshour -- The Business Desk: What's the Relationship Between Inflation and Interest Rates?
Solomon Poretsky has been writing since 1996 and has been published in a number of trade publications including the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." He holds a Bachelor of Arts, cum laude, from Columbia University and has extensive experience in the fields of financial services, real estate and technology.