What Makes Currencies Go Up and Down?

Fluctuation Caused By Supply And Inflation

A currency’s fluctuation can be caused by a variety of reasons. One of the major reasons for the fluctuation in a currency’s value is the amount of currency that is already in circulation when compared to the inflation.

Currency Value Fluctuation

When a country prints money. The value of its domestic currency gets diluted because of inflation, thus weakening the currency, in comparison to that of other countries. It is the basic rule of supply and demand. In a hypothetical scenario, if a large amount of money were to suddenly disappear, and there would be a dearth in supply for it, the currency would strengthen in comparison to other countries, causing the value of the currency to go up.

See also: Top 15 Weakest Currencies in the World

Fluctuation Caused By Demand

Value of a currency is also affected by the demand for the currency. Its desirability leads to the demand for it and this demand reflects in the valve of the currency going up. The more foreign countries want to hold onto a foreign currency, the higher the perceived the value. And the higher the perceived value, the higher its worth. Similarly, if foreign countries are disinterested in holding onto a foreign currency, it drops in value and worth, causing it to plummet in comparison with other countries.

Some factors like inflation in a country, the interest rate, the political environment and the trade balance of a country, go a long way in influencing the demand for a currency. A common occurrence of currency devaluation is when a country gears up to go into a war with another country. Wars are expensive and pose economical risks with long term effects.

See also: List of Strongest Currencies Worldwide

If you knew a country was going into a losing war, which would end with the capitulation of the government and its economy, you would probably not want to sell all the investments you made in that currency, in order to not risk making a loss. When a lot of people are dumping a currency on the open market, it’s clear that there is no demand for it. Subsequently, devaluing the currency and causing it to go down.

Live exchange rates are considered to be good indicators of the desirability of a currency, when compared with a different one.

Fluctuations Cause By The Change In The Purchasing Power Of A Currency

In an ideal world or a perfect market scenario, the purchasing power of all currencies would be equal. That means, a consumer would be able to purchase the same number of goods, even if they exchanged their money and bought them in another country. This ideal purchasing power is just that, an ideal. It does not work like that in the real world. The reasons why it does not work in the most ideal way are aplenty. Trade barriers, competition, and prices that do not automatically reflect an adjustment in the value of a currency are some. This can be best felt when visiting some countries that feel extremely expensive to visit, while some seem very cheap.

When one currency has greater purchasing power in comparison with another, that currency is estimated to be undervalued. By the same logic, a currency with a weaker purchasing power is considered to be overvalued. For example, if a Pizza slice costs 2 US Dollars in the US and 2 British Pounds in the United Kingdom, but 1 US Dollar will get you only half a British Pound or 50 Pence. In this situation, the British Currency is considered to be overvalued, since you cannot purchase as much as you could with the US Dollar.

Fluctuations Caused By Other Factors

Currencies go up when there is any sort of appreciation in its value. Rise in the value of the currency can be through foreign investment or increase in the demand of the currency in international markets. Rise in production, where an increase in exports can be seen, leads to a significant jump in foreign capital being injected into the economy too. This leads to a positive fluctuation, with the currency going up. Similarly, any rise on the stock market and increase in policies of the central bank, where interest rates are regulated, generally help in appraising the value of the currency.

Just like there are factors that lead to the value of currencies going up, there are also some factors that cause the value of the currency to go down. The value of a currency depreciates when its imports increase, leading to a lot of domestic currency leaving the country. A currency is always valued to be weak, if the imports in its countries are higher than its exports. Stock exchange drops and crashes also lead to the value of the currency going down. Policies of the central bank can also play an adverse role in the negative fluctuation of a currency. This happens when a central bank sells its currency to buy Gold. This is considered to be a sign of economic instability of a country, causing the value of the currency to plummet.

In conclusion, these are the reasons why you can see a constant fluctuation in the value of a currency.

See also: What Affects Foreign Exchange Rates?

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