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  • Writer's pictureJamie Clark

Currency Value: Understanding and Navigating Exchange Rates

Updated: Aug 21, 2023


Context


Our currency has no intrinsic value.


If I gave you a $10 note, the note itself is not worth anything.


What gives the $10 note value relies on the trust and confidence in the issuing authority. And in this case of fiat currency, the government is the issuing authority.


Throughout history, people have developed mechanisms to exchange value. In the past, you might have exchanged 1 goat for 100kg of rice. The underlying principles of such exchange are not dissimilar to what we experience today.

 

In the global economy, currencies play a pivotal role in facilitating trade and investment across borders.


And, the value of currencies is not always stable. In fact, exchange rates fluctuate constantly, and understanding the reasons behind these changes is crucial for businesses, investors, and travellers alike.


Here are the five top things to look out for when it comes to currency:


Why Does Currency Change Value?


1. Economic Indicators: One of the primary drivers of currency value is a country's economic health. Strong economic indicators, such as high GDP growth, low unemployment, and rising industrial production, tend to strengthen a currency's value. Moreover, foreign investors are attracted to strong economies, leading to increased demand for the country's currency.


2. Interest Rates: Central banks use interest rates as a tool to control inflation and stimulate or stabilise the economy. Higher interest rates attract foreign investors seeking better returns on their investments, leading to increased demand for the currency. Keep in mind though, if the interests are too high (Zimbabwe, Venezuela, Argentina), this rule does not apply.


3. Inflation: Inflation erodes the purchasing power of a currency. When a country experiences higher inflation compared to its trading partners, the value of its currency may decrease relative to theirs.


4. Trade Balance: The trade balance, which is the difference between a country's exports and imports, also influences currency value. A trade surplus (more exports than imports) tends to strengthen the currency, as foreign buyers need to purchase the domestic currency to pay for goods. Conversely, a trade deficit can lead to a weaker currency.


5. Political Stability: Political uncertainty and instability can significantly impact a currency's value. A country with a stable government and favorable policies is more likely to attract foreign investment, which bolsters its currency.


And why is it important to care about currency? (as an individual)


Keeping an eye out on the XE app can be a good thing to do.


Benefits Include:


Increased Purchasing Power: A strong currency gives individuals greater purchasing power, allowing them to buy more goods and services both domestically and from abroad. This means they can enjoy a higher standard of living and access a wider range of products without spending as much. This is also helpful when travelling abroad.


Education Opportunities: Studying abroad becomes more accessible and affordable with a strong currency. Tuition fees, living expenses, and other costs are relatively lower, enabling individuals to pursue higher education in foreign countries.


Investment Opportunities: Individuals with a strong currency can explore international investment opportunities more effectively. They can invest in foreign assets or businesses, diversifying their investment portfolios and potentially gaining from global economic growth.


Lower Imported Inflation: A strong currency can help keep inflation in check by reducing the cost of imported goods. This leads to a stable cost of living for individuals, making budgeting and financial planning more predictable. Example, Switzerland has reported 2022 inflation of 3.5%, the Euro zone reported 10.6% inflation.


Greater Savings Potential: When a currency is strong, individuals may have more incentive to save money since their purchasing power is protected against currency devaluation and inflation risks. Psychologically, it puts people into a savings mindset.


 

Currency strength and stability


Currency strength is important, but currency stability is critical. This is because it adds for a layer of predictability that the money you are earning today will have relatively similar value, and therefore stable life implications later on.


Most Stable currencies as of 2023
Most Stable Currencies

On the other side of the spectrum


The Argentinian peso (ARS) is one of the most well-covered failings of a local currency. Historically, there has been little domestic confidence in the longevity of pesos, and thus many Argentinians will ask for their salaries to be paid directly in USD, and if that is not a possibility, they will try to exchange their pesos to USD immediately.


However, not all Argentinians have the means to make fast transactions to USD, and therefore have suffered deeply.


Chart: XE

USD to Argentinian Peso last 5 years (2018-2023)
USD to Argentinian Peso last 10 years (2013-2023)

In August 2013, one US Dollar was worth 5.5 ARS. 10 years later, 1 USD is officially worth 349 ARS. That is 60 times more.


This can have crippling effects for people who have spent decades working hard and saving, only to have their government fail them.


I recommend watching this 6 minute clip from DW News (published June 2023) about the situation in Argentina.



Decentralised currencies to the rescue?


This is a key reason as to why cryptocurrencies like Bitcoin caught traction in countries like Argentina and El Salvador - because the public felt that decentralised currencies could be more stable then their own local currency. Over the past years, it has been proven that Bitcoin was not the magic answer, but with governments failing to protect their citizens' money - can you blame them for trying something else?


In this graph below you can see observe the key difference between centralised and decentralised currency.


Centralised vs decentralised currency
Difference between centralised and decentralised currency

This means that the definition of value are opposites.


Fiat currencies are defined by the inside, out. Government actions will determine the value of the currency.


Cryptocurrencies are from the outside, in. Governments cannot affect the price of bitcoin, because it the price is dictated by what people think it should be worth, and how widely accepted it is in society.


In recent years, many people have shifted their attention away from cryptocurrencies and back to fiat currencies. This shift occurred because the cryptocurrency industry struggled to offer the stability that many individuals were seeking. However, the concepts of blockchain and decentralised currency continue to be important - and could potentially experience a surge in popularity in the near future.


 

Conclusion



Ultimately, currency exchange is more than just a financial transaction – it's a reflection of the dynamic forces shaping our global economy.


By comprehending these forces and their implications, individuals and businesses can make more informed decisions to navigate the complexities of international trade, investment, and travel.


So, whether you're a world traveler or just a curious observer, understanding currency exchange empowers you to navigate the ever-changing currents of the global financial system.


I hope you enjoyed this article!

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