Reasons for Change in Currency Value

It's a belief widely held that speculators are the reasons for swings in currency exchange rates. However, this is only partly true. There are in fact, other reasons for the fluctuation in values of currencies.

The Forex market is a huge business, in fact billions and billions of dollars flood into this market on a daily basis. In general, most people buy foreign currencies simply because they need to purchase goods or services from other countries. For example, a U.S. importer may purchase Japanese yen to buy Japanese autos.

A Chinese financial investor purchase Australian dollars to invest in the Australian stock market. However, there is another group of participants in the currency market -- speculators --that buy and sell foreign currencies in the hope of reselling or re-buying them in the future at a profit.

Factors Influencing Exchange Rates Fluctuation

Based on findings, during the late 1997 and 1998, speculators were much in the news when they were widely accused of driving down the values of several currencies which include the south Korean won, Thailand baht, Malaysian ringgit, and the Indonesian rupiah. Within a month, the value of these currencies declined as much as 50 percent. Beyond all reasonable doubts, speculators did contribute to the swiftness of these declines. The expectation of currency depreciation or appreciation, can be self-fulling.

If speculators for example, expect the euro to be devalued or to depreciate, they quickly sell euro and buy currencies which increase in relative value. The sharp increase in the supply of euro indeed reduces its value; this reduction then may trigger further selling of euro in expectation of further declines in its value.

But economist believe that speculations aren't generally the only underlying causes for changes in the value of currencies, rather, it's the change in economic realities. In fact, they believe that was largely the situation with the Southeast Asian countries in which actual and threatened bankruptcies in the financial and manufacturing sectors undermined confidence in the strength of the currencies.

If or when Speculators are anticipating eventual declines in currency values, they simply speed up that decline. However, a reduction in value of those currency probably would have happened with or without speculation. Moreover, on a daily basis, Speculators clearly has positive effects in foreign exchange markets.

when temporary weak demand or strong supply drives down the value of a currency, Speculators quickly buy that currency, adding to its demand, and causing its value to rise. Whenever there is a strong temporary demand or a weak supply of a particular currency, this will cause the price of that currency to increase in value. At this point , Speculators will sell this currency, causing the supply of this currency to increase, thus reducing its value.

In this way, Speculators somewhat levels out supply and demand. This stabilization of exchange-rate in turn aids international trade a great deal. In short, although Speculators in currency markets occasionally contribute to swings in exchange-rates, on a daily basis, they also play a positive role in currency markets.

Below are examples of several factors which can change the demand for or supply of a particular currency thus altering the exchange rates, according to economist:

Scenario 1A. When There is a change in Taste:- If Japanese autos were to decline in popularity in the U.S. (result - Japanese yen would loose value or depreciate,and the U.S.dollar would gain value or appreciates.)

1B. If for some reasons, German Tourists have decided to flock to the U.S. (result - This would cause the U.S. dollar to appreciate and the German marks to depreciate)

Scenario 2:- In the case of a change in Relative Income:- Say for example, England encounters a recession, causing its import to reduce, while U.S. real output and real income surge, thus increasing U.S. imports (British pound would appreciate whereas the U.S. dollar would depreciate).

Scenario3:- Change in Relative Prices:- Say, Germany have experienced a 3% inflation rate compared to a 10% rate experienced by Canada(German mark would appreciate, while the Canadian dollar would depreciate).

Scenario4:- A Case Where There is change in relative Real Interest Rates:- Say the Federal Reserve has made the decision to drive up interest rates in the U.S, while the Bank of England has taken no such action(Then the U.S. dollar would appreciate; British pound would depreciate).

Conclusion

To summarize,based on the scenarios above, Speculators alone don't contribute to the swings in currency exchange rates, other socioeconomic factors within different regions or countries also play a huge role.

(C)I.M. 2012..x.x.x