What Makes Currency Rise or Fall?

February 19, 2009 by Tyrone
Filed under: Finance Concepts, On the Spotlight

I remembered before that I chatted with a foreign exchange (forex) trader when I was thinking to try foreign exchange trading online as one of investing. And I asked him: “What Makes Currency Rise or Fall?”

In our discussion through Yahoo Messenger, he stated that currency trading is more stable than the stock market. He said that ‘currency trading is a balancing act between a particular currency against a basket of other currencies.’

If one currency fall, then definitely other currencies will rise. Comparing it to stock market, if there is a rampant fear among investors, then definitely all stocks will get affected. So what really makes a particular currency rise or fall?

He continued to answer the question by telling me that they use programs and charts such as Moving Average Convergence and Divergence (MACD) and Bollinger. When I searched it in the internet, these are technical analysis charts and graphs that use historical value in order to predict future value. But even the historical value has some basis right?

He ultimately said that the strength of a currency depends on its demand. It’s the universal law of supply and demand. When a demand for a currency is high, then that particular currency will rise. Conversely, when the supply of a currency is higher than its demand, then it will fall against other currencies.

The next logical question will be: “Now, what does a country makes in order to make its currency more demanding or attractive to others?” The answer to this question relies on the treasury of one country particularly interest rates. It’s comparable to a bank. Definitely, a bank depositor will seek banks that gives the highest interest rates.

Then why can’t all treasury of each country just increase their interest rates in order to have their currencies appear demanding or attractive? It’s not that easy. In fact, it requires a skillful balancing act by the treasury to ensure the flow of money (i.e. inflow and outflow) If there’s a “too low” interest rates, then the currency will fall. But if there’s a “too high” interest rates, then the economy will suffer as it will require investors such as entrepreneurs to borrow money at a much higher interest rates to use as their capital for business growth and expansion.

When I was a kid, I was puzzled that why can’t a country just print more and more currency and give it to its citizens so that they can all be rich? I learned that it’s not that easy. Again, it’s the law of supply and demand. Too much money in the system will make inflation rates to rise and it will push commodity prices to go up.

This was the case for the country Zimbabwe having one of the worst valued currency in the world. In Zimbabwe, everybody is considered as a billionaire! You might be shocked but it’s definitely true! How come? Well, they have one of the highest, if not the highest, inflation rates in the world. Their economy is suffering from hyperinflation. When you trade their currency to, say for example US Dollar, the currency trading is: 1 US$ ~ 1 Billion Zimbabwe Dollars.

Wow. It’s as if their currency has no value at all. In fact some of the news that I saw, some of the locals there used their local currency as tissue papers to wipe their ass in toilets. In fact, you will need to use ‘billions’ of dollars just to buy “cheap commodities”. Let’s view some of them:

One Hundred Billion Dollars is the cost of just three eggs

A “typical receipt” in their restaurants

And a lot of “billionaires” even as young as a kid

Sometimes, they don’t count anymore but they just use the weighing scale

What happened to Zimbawe’s economy? What made their currency fall too low as if there’s no more value into it? Their inflation rate increased by as much as 200 Million percent! Many locals turned to their leader Mugabe as the culprit. He literally destroyed the banking system when he forcefully got the lands from their farmers without any remuneration. The effect? Their economy collapsed!!!

While some issues were already resolved, there’s a question that still kept me thinking: Why do the currency of some prosperous countries such as China (currency Yuan) and Japan (currency Yen) were considered “low” compared to the US Dollar? Shouldn’t be their currencies appear attractive and more demanding than the others since their economies were doing well?

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Comments

12 Comments on What Makes Currency Rise or Fall?

elmot blogger on Thu, 19th Feb 2009 8:04 pm

that is why mugabe is now being tried for all his corruption…i think what marcos did made the value of our currency fall too…

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Gio on Sun, 22nd Feb 2009 9:03 am

just passing by…hehe…

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Ryan on Thu, 26th Feb 2009 2:19 am

Nice Blog… I am into forex trading. Good thing I learned something from the economy of Zimbawe… Do you trade forex?

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admin on Thu, 26th Feb 2009 5:21 pm

Hi Ryan, thanks for the commendation. No, I don’t trade forex but I want to try and learn it. They say it’s a good alternative investment on the stock market especially nowadays that stocks are suffering a very bear market.

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lily on Tue, 28th Apr 2009 5:28 am

Hi admin! It’s me again! I’ve read your posts about stock trading and I think I’m not yet ready for that kind of investment, esp now that stocks are going down again because of the swine flu issue. I’ll try to read more about forex trading, hopefully this won’t require a huge capital. Last February, I bought AUD$ 1,000 (AUD$1 = P31) from a friend. Now the rate is at 34 something. I hope it’d be back at P38 a dollar lol!

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Tyrone on Tue, 28th Apr 2009 4:14 pm

Hi Lily, thanks for the visit again. As for me, I think I won’t hold on long term on forex unlike stocks. I had a friend who trades forex online. He’s making some nice profits in a week’s time, but eventually lost all of it including a decrease in his original principal on the second week.

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lily on Wed, 29th Apr 2009 2:00 am

Really? I’m planning to sell them this week. I still have no idea on how to trade forex online.

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Peter on Mon, 22nd Jun 2009 9:18 am

Thanks for the information. There seems to be a never ending supply of great information on the net. I love learning new stuff, and will be back to read your posts regularly !! Thanks again

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Ruben on Thu, 1st Oct 2009 5:46 am

Great article! Thx!

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Frank Tremas on Thu, 5th Nov 2009 6:15 am

Lily,

If you don’t know how to trade in the forex market then don’t start trading until you have learned at least the basics. You can make a lot of money in forex trading, but you can also lose a fortune.

[Reply]

Ian Antono@Currency Forex Trading on Mon, 30th Nov 2009 2:50 am