Effect of Currency Fluctuations on the Economy

Effect of Currency Fluctuations on the Economy

Currency fluctuations are a natural result of a floating exchange rate system which is the norm for most major economies. The exchange rate of one currency with another is influenced by many fundamental and technical factors. This includes relative supply and demand from both currencies, economic performance, inflation prospects, differences in interest rates, capital flows, levels of technical support and levels of resistance and so on. Because these factors are generally in a continuous state, the value of a currency fluctuates from one time to another. But even though the level of a currency must be largely determined by the underlying economy, the tables often change because large movements in the currency can determine economic fate. The following is the effect of currency fluctuations in the general economic sphere.

Remote Currency Effects To Achieve

While the impact of currency fluctuations on the economy is far to be reached, the majority of people pay little attention to the exchange rate because most businesses and transactions are carried out in domestic currency. For this type of consumer, the exchange rate is only focused on certain activities or transactions such as foreign travel, import payments or remittances abroad.

A common mistake most people have is the opinion that a strong local currency is a good thing because it makes travel to Europe cheaper. But the fact that a currency that is too strong can provide a significant obstacle to the underlying economy in the long run because the entire industry is considered uncompetitive and thousands of jobs will be lost. Meanwhile, consumers may underestimate the weak local currency because it makes foreign travel more expensive, but the fact that a weak currency can generate more economic benefits.

The value of the domestic currency on the forex market is an important instrument in the central bank’s toolkit. In addition, it is also a major consideration when setting monetary policy. Directly or indirectly, the currency level affects a number of key economic variables. They may play a role in the interest rate you pay for the mortgage, the rate of return on your investment portfolio, the price of groceries at the local supermarket or maybe even your job prospects.

The Effect of Currency Fluctuations on the Economy

Currency rates have a direct impact on economic aspects, as follows:

  • Trade in Merchandise

This refers to international trade such as exports or imports. In general, a weaker currency will stimulate exports and make imports more expensive so as to reduce a country’s trade deficit over time. Domestic currency depreciation is the main reason why the export business remains competitive in the international market.

On the other hand, a stronger currency can reduce export competitiveness and make imports cheaper so that it can cause greater trade deficits which eventually weaken the currency. But before this happens, a very export-oriented industrial sector can be destroyed by a currency that is too strong.

  • Capital Flows

Foreign capital tends to flow to countries that have strong governments, dynamic economies and stable currencies. A country needs to have a relatively stable currency to attract foreign capital. If not, then the prospect of exchange losses caused by currency depreciation can deter foreign investors.

Capital flows can be grouped into two types, namely direct foreign investment or Foreign Direct Investment (FDI) and foreign portfolio investment. FDI is a condition where foreign investors take shares in existing companies or build new facilities abroad. While foreign portfolio investment is a condition in which foreign investors invest in foreign securities.

Currency fluctuations can have a broad impact, not only on the domestic economy but also at the global level. Investors can use these steps to take advantage by investing abroad or in multinational companies. Now read on about the types of capital flows in the Online Forex article below, yes!

  • Review of Advanced Capital Flows

Just a little flashback that capital flows can be grouped into two types, namely foreign direct investment (FDI) and foreign portfolio investment. FDI is a condition where foreign investors take shares in existing companies or build new facilities abroad. While foreign portfolio investment is a condition in which foreign investors invest in foreign securities.

FDI is an important funding source for economic growth such as India and China whose growth can be hampered if there is no available capital. The government itself prefers FDI investment than foreign portfolio investment, because the latter often resembles hot money that can leave the country when conditions are difficult. This phenomenon is commonly called “capital flight”. This condition can be triggered by negative events including currency devaluation.

  • Inflation

A devalued currency can generate import inflation for countries that are substantial importers. A 20% reduction in domestic currency can result in imported products costing 25% more because a 20% reduction means requiring a 25% increase to return to the starting point.

As previously explained that interest rates are the key consideration for most central banks when they are going to set monetary policy. A strong domestic currency will provide obstacles to the economy to achieve the same end result with tighter monetary policy. Besides that further monetary policy tightening when the domestic currency is too strong can worsen this problem.

How Can Investors Get Profits?

For those of you who are investors and up to now do not know how to benefit from currency movements, then consider the following methods …

  • Investing Abroad

If you are an investor based in America and believe that the USD is in a downward condition, invest in a strong foreign market because your profits will be driven by appreciation of foreign currencies.

  • Invest in US Multinational Companies

The United States has the largest number of multinational companies where most of them earn income from abroad. The income of US multinationals is driven by the weakening dollar.

  • Stop Borrowing Foreign Currency with Low Interest

This is indeed not an urgent problem because US interest rates are at record lows for years. But someday this interest rate will return to a higher level. Never borrow low-interest foreign currency if you don’t understand or cannot protect the value of exchange risk.

  • Foreign Currency Risks

Currency movements that can adversely affect your finances significantly, especially if you have large forex exposure. But calm, there are many options available to hedge the risk of currency exchange. If your currency risk is large enough, consider protecting this risk.

Conclusion of Currency Fluctuations

Currency fluctuations can have a broad impact, not only on the domestic economy but also at the global level. Investors can use these steps to take advantage by investing abroad or in multinational companies. Because currency fluctuations can be a potential risk when someone has a large foreign exchange exposure. Then maybe you should protect this risk through several existing hedging instruments.

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