How does currency appreciate

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Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. This refers to a nation's imports and exports. In general, a weaker currency makes imports more expensive, while stimulating exports by making them cheaper for overseas customers to buy. A weak or strong currency can contribute to a nation's trade deficit or trade surplus over time.

For example, assume you are a U. A weak U. Conversely, a stronger currency can reduce export competitiveness and make imports cheaper, which can cause the trade deficit to widen further, eventually weakening the currency in a self-adjusting mechanism. But before this happens, export-dependent industries can be damaged by an unduly strong currency. From this equation, it is clear that the higher the value of net exports, the higher a nation's GDP. As discussed earlier, net exports have an inverse correlation with the strength of the domestic currency.

Foreign capital tends to flow into countries that have strong governments, dynamic economies, and stable currencies. A nation needs a relatively stable currency to attract capital from foreign investors. Otherwise, the prospect of exchange-rate losses inflicted by currency depreciation may deter overseas investors. There are two types of capital flows: foreign direct investment FDI , in which foreign investors take stakes in existing companies or build new facilities in the recipient market; and foreign portfolio investment , in which foreign investors buy, sell and trade securities in the recipient market.

FDI is a critical funding source for growing economies such as China and India. Governments generally prefer FDI to foreign portfolio investments, because the latter is hot money that can leave the country quickly when conditions grow tough. This capital flight can be sparked by any negative event, such as a devaluation of the currency. A devalued currency can result in "imported" inflation for countries that are substantial importers.

As mentioned earlier, exchange rates are a key consideration for most central banks when setting monetary policy. In September , Bank of Canada governor Mark Carney said the bank took the persistent strength of the Canadian dollar into account when setting monetary policy. Carney said the Canadian dollar's strength was one reason why his country's monetary policy had been "exceptionally accommodative" for so long.

A strong domestic currency exerts drag on the economy, achieving the same result as a tighter monetary policy i. In addition, further tightening of monetary policy at a time when the domestic currency is already strong may exacerbate the problem by attracting hot money from foreign investors seeking higher yielding investments which would further strengthen the domestic currency.

However, there are times when currencies move in dramatic fashion and the reverberations are felt around the world. We list below a few examples:. A prime example of the havoc caused by adverse currency moves is the Asian Financial Crisis , which began with the devaluation of the Thai baht in summer of The devaluation occurred after the baht came under intense speculative attack, forcing Thailand's central bank to abandon its peg to the U.

This currency contagion spread to neighboring countries such as Indonesia, Malaysia and South Korea, leading to a severe contraction in these economies as bankruptcies soared and stock markets plunged. Between and , China held the renminbi steady at about 8. In , China responded to the growing chorus of complaints from the U. Two of the most important are:. Where low inflation rates persist, central banks tend to cut interest rates to try and stimulate spending in the economy.

A lower interest rates means holding the currency becomes less attractive relative to currencies that pay a higher interest rate. This typically results in less demand for the currency and often causes the currency to depreciate, however it is not always so finely out. For example, Switzerland has long been considered a safe haven for investors, which means the currency appreciates in times of economic crisis.

This is because of its historic neutrality in wars and tendency towards political stability and relatively free monetary policy; as well as its openness to foreign investment. These policies have made the Swiss franc one of the most heavily-traded currencies in the world.

Investor sentiment heavily influences the supply and demand for a currency on the open market, which are perhaps the largest drivers behind whether a currency appreciates or depreciates. The currencies which are most susceptible to influence by supply and demand are those that operate on a floating exchange rate.

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