Should I be worried when a currency fluctuates? Here’s what you need to know
Dubai: a fluctuating currency? These are just the changes in the value of one currency against another.
If a US dollar is worth one value in your home country’s currency today and then another value tomorrow, how does that affect you or anyone who earns in such a currency?
You may think that you have or earn the same amount of money before the last depreciation in the value of the currency. Thus, you can buy the same quantities of goods or services as before.
However, it doesn’t work that way. Let’s unpack this and first consider how a weakening currency affects us – albeit indirectly.
How do currency fluctuations impact us?
“As one of the main determinants of a country’s level of economic health, exchange rates are one of the most analyzed economic measures on the planet,” remarked Ebin Wilson, a forex specialist based to Dubai.
“That’s why it’s crucial to know exactly what influences exchange rates and why they matter so much to everyone from governments and large financial institutions to retail investors.”
Knowing exactly what influences exchange rates and why they are so important to everyone is crucial
– Ebin Wilson, Dubai-based forex specialist
When a currency slips, the government will have a reduced ability to spend on building infrastructure and other social projects. Investment decreases, which in turn affects the number of unemployed, which will affect the residents of a country the most.
A falling currency also makes studying and traveling abroad more expensive, as your fees and tickets cost more than the value of the US dollar. On the other hand, this is also why a stronger currency will benefit you.
How Oil Prices Affect Currencies
High crude oil prices not only mean more expensive gasoline and diesel for vehicle owners, but transporting essentials including fruits, vegetables, edible oil and food grains also costs more. dear.
All of this leads to inflation and the depletion of our foreign exchange reserves because we send more dollars on crude oil. This reduces our ability to import other goods that we need.
“If the relevant currency belongs to a country that depends on imports, this leads to fewer and more expensive foreign goods, and further weakening of the currency. If you shop, you spend more,” explained Wilson.
“If you rein in spending, it leads to lower demand for goods and services – activities like construction, manufacturing and imports slow down. Businesses can hire fewer employees. The overall economy takes a hit You feel the pinch of falling currency.
Who decides the value of a currency?
A currency is a state of flux that arises from the inequality of supply and demand in the foreign exchange market, an institution for the exchange of one country’s currency with that of another country.
Simply put, currencies fluctuate based on supply and demand for a given currency. Most global currencies are bought and sold on the basis of flexible exchange rates, which means that their prices fluctuate according to supply and demand in the foreign exchange market.
Foreign currency exchange rates are floating and depend on day-to-day market factors such as demand and supply, with no or minimal intervention from the countries involved. The higher the demand, the higher the value.
For example, heavy imports, which means more dollars purchased, decrease the value of the Indian currency, the Indian Rupee (INR). Similarly, in the case of massive exports, more dollars will flow into India and become cheaper for residents to buy through Indian rupee.
3 key economic factors that cause the value of a currency to fluctuate
• Monetary Policy
Central banks in many countries attempt to control the demand for currencies by increasing or decreasing the money supply and/or benchmark interest rates. Money supply is the amount of a currency that is printed and in circulation.
As a country’s money supply increases and currency becomes more available, the price of borrowing currency decreases. The interest rate is the price at which money can be borrowed. With a low interest rate, individuals and businesses are more willing and able to borrow money.
As they continually spend this borrowed money, the economy grows. However, if there is too much money in the economy and the supply of goods and services does not increase accordingly, prices start to inflate.
• Inflation rate
Another variable that strongly influences the value of a currency is the rate of inflation. The rate of inflation is the rate at which the general price of goods and services increases.
While a small amount of inflation indicates a healthy economy, too much of an increase can cause economic instability, which can ultimately lead to currency depreciation.
A country’s inflation rate and interest rates strongly influence its economy. If the inflation rate gets too high, the central bank can counter the problem by raising the interest rate. It encourages people to stop spending and save their money.
It also stimulates foreign investment and increases the amount of money entering the market, which leads to increased demand for currencies. Therefore, an increase in a country’s interest rate causes its currency to appreciate. Similarly, a fall in an interest rate leads to a depreciation of the currency.
• Political and economic conditions
Economic and political conditions in a country can also cause the value of a currency to fluctuate. Although investors benefit from high interest rates, they also appreciate the predictability of an investment. This is why the currencies of politically stable and economically sound countries generally have a higher demand, which, in turn, leads to higher exchange rates.
The markets constantly monitor the current and expected future economic conditions of the countries. Apart from changes in the money supply, interest rates and inflation rates, other key economic indicators also include the unemployment rate and the trade balance (a country’s total exports minus its total imports) . If these indicators show a growing economy, its currency will tend to appreciate as demand increases.
Likewise, strong political conditions have a positive impact on currency values. If a country is in the midst of political unrest or global tensions, the currency becomes less attractive and demand drops. On the other hand, if a market sees the introduction of a new government that suggests stability or strong future economic growth, a currency may appreciate as people buy it based on good news.
How is the value of different currencies fixed or measured?
The most common way to measure the value of a currency is to measure its convertibility into other currencies, also known as the exchange rate.
1. Fixed exchange rate
A pegged exchange rate is when a country pegs its currency to an anchor currency so that the two currencies move identically. Countries that opt for a fixed exchange rate are generally developing countries.
The most common anchor currency is the US dollar, as it is relatively stable and considered a safe haven in times of crisis. Sometimes a country may also peg the value of its currency to a basket of currencies.
2. Floating exchange rate
A floating exchange rate involves letting the foreign exchange market determine the currency’s value relative to the supply and demand of other currencies. Countries subject to a floating rate system may experience greater exchange rate volatility.
However, countries with floating exchange rates also enjoy greater autonomy. The government usually still intervenes occasionally to keep the exchange rate within a reasonable fluctuation band.
How to stop currency fluctuations?
Central banks and governments can intervene to help stabilize a currency by selling foreign exchange or gold reserves, or by intervening in foreign exchange markets.
Foreign exchange intervention can be done in two ways. First, a central bank or government may assess that its currency has slowly become out of sync with the country’s economy and is having negative effects on it.
For example, countries that rely heavily on exports may find that their currency is too strong for other countries to buy the goods they produce. They can intervene to align the currency with the currencies of the countries that import their goods.
Conclusion: Why understand currency fluctuations?
Currency fluctuations have a significant impact on us. For example, buying a foreign car can become more expensive if your country’s currency depreciates, meaning you might end up paying more money for an item of the same value. On the other hand, a stable currency allows us to buy more.
When traveling abroad, one of the routines you have become accustomed to is exchanging your currency for the local currency. Many people are surprised at the different amounts of local currency they have after returning their change.
Clearly, the fluctuation of global currencies is a constant in volatile international capital markets. Therefore, there can be many ways to capitalize on strong currency fluctuations.
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