15/10/2020
The currency value of “major” currencies (the most used for commerce and international trade) – such as the US dollar, the euro, the Japanese yen, or the British pound – depends on the market price. The rate of currencies varies continuously, depending on volumes of transactions in the trading markets (banks, stock exchanges, Forex).
What determines the currency value?
The level of interest rates – commonly referred to as the “money rent,” is one of the most important factors influencing the formation of a specific currency’s value. If a country offers high-interest rates, investments in that currency are profitable for international investors, and therefore it supports the value of the currency.
A currency’s value comes from the confidence placed in a specific country, based on the importance of its wealth, stability, economic growth, and strategic power. Not by surprise currencies of largest economies are traded the most.
If a country has, for example, large trade deficits (flow of goods) this weighs on the value of its currency, which normally depreciates.
When countries have important exchanges between them, their currency values are often linked. On the foreign currency exchange market, the price of certain currencies evolves partially or even entirely following the euro’s value, which is the case of Central and Eastern Europe’s currencies, of the British pound – or of the Scandinavian currencies such as Norway and Sweden.
Advantages of a strong currency
The Foreign currency exchange market is one of the largest on the planet, with the daily transactions of nearly $ 5 trillion. The currency market makes international trade easier. The most popular currencies to which many national currencies are pegged is the US dollar, the yen, the euro, and the Swiss franc. They are also called safe-haven currencies. Any currency price fluctuation can lead to repercussions on the country’s economy. In general, a strong currency means a strong national economy.
Also, strong currency limits price increase and lowers the cost of credits because the interest rates are low as the inflation is low. It reduces the cost of foreign investments. In fact, with a strong currency, acquisitions are cheaper. Strong currency increases purchasing power for goods and services invoiced in weaker currencies. The challenge for many nations is to avoid exchange losses when purchasing goods denominated in foreign currencies. This leads importers to use some hedging techniques.
The strong currency reduces the price of commodity supplies such as gas and oil imports. Strong currency countries like the United States prefer to acquire oil stocks abroad than to develop their local production.
The strengthening currencies’ capital flows from abroad usually go into the government bonds, which lower the yield and, at the same time, enable the country to raise money at lower rates..
With a stronger currency, citizens can do more in terms of having a cheaper vacation abroad. They can experience much more with their travel funds, allowing them to go on vacations that have been unaffordable for them in the past.
Central Banks’ interventions on foreign exchange market
Central banks (European Central Bank, American Federal Reserve, Bank of Japan, etc.) – which issue currencies and set the level of short-term interest rates – can influence the Forex market, for example, when they find that the speculation goes too far up or down.
There are countries where the government controls the currency directly, like in China. In Japan and Switzerland, the government intervenes in the market directly. Even the countries that are considered having a free market are not entirely free such as Canada, New Zealand, and Australia where currency interventions also occur from time to time.
The most effective interventions are those carried out by the two countries’ central banks concerned, for example, the American Federal Reserve (Fed) in conjunction with the European Central Bank (ECB) to influence the dollar-euro parity. This happened in September 2000 when the Fed and the ECB sold dollars and bought euros to support the single European currency’s price, which fell to $ 0.89.
As you can see, there are many positive impacts of the strong currency on national economies. However, there could also be many disadvantages such as trade abroad in decline, more expensive exports, and national tourism in decline. All in all, the strong currency is a two side coin.
15/10/2020
