Rise and Fall of Currency

 Rise and Fall of Currency 

"Currency trading is a balancing act between a particular currency against a basket of other currencies. If one currency falls, then definitely other currencies will rise." 

Rise and Fall of Currency 

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 value of a currency depends on factors that affect the economy such as imports and exports, inflation, employment, interest rates, growth rate, trade deficit,performance of equity markets, foreign exchange reserves, macroeconomic policies, foreign investment inflows, banking capital, commodity prices and geopolitical conditions. A country's currency may not always mirror economic conditions, a country may have a very robust economy but its currency may remain weak relative to other currencies but how is it possible? The answer lies in speculation, everyday, currencies are traded against each other relying mostly on technical factors than its fundamentals. 

The next logical question will be "Now, what does a country do 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 give 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 are too low' interest rates, then the currency will fall. But, if there are 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.

 It puzzles, then 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? 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. In fact, you will need to use "billions of dollars just buy cheap commodities'. One Hundred Billion Dollars is the cost of just three eggs. Sometimes, they don't count anymore but they just use the weighing scale. All this happened as a result of faulty economic policies like confiscation of land from farmers by government for free, printing more currency, destroying banking system etc.

 The world needs a standard currency in which international trade and transactions could be carried out. The currency of USA, i.e., Dollar is the unofficial standard currency of the world. It's history dates back to July 1944 when an agreement was reached at the United Nations Monetary and Financial Conference which pegged the value of gold at US $ 35 per ounce and the whole world looked on US $ as the gold standard in purchases. But in 1971, US President Nixon took the US off the gold standard after his administration realized that the US no longer had enough gold to buy back every dollar that foreign governments were handing in. 

In 1973, US President Nixon asked King Faisal of Saudi Arabia to accept only the US $ in payment for oil, and to buy US Treasury bonds, notes and bills with their excess profits, so that USA can continue spending money and not Pay it back. In return, the USA pledged to protect Saudi Arabian oil fields from Seizure by USSR and other nations including Iraq and Iran. The 1973 Arab-Israeli War upset this agreement and caused the Great Oil Embargo of 1974. By 1975, the Great Oil Embargo was over and all members of oil only in US $. Every nation was saving their surpluses in US $ since every country needed US $ to buy oil. The OPEC oil sales supported the US S. 

Since, only the US Federal Reserve can print the US $, the US control the flow of oil. The US essentially owns the world's oil for free because oil is denominated in US $ and the US $ is the only fiat currency for trading in oil . Because oil is an essential commodity for every nation, the Petrodollar system, which exists to the present, demands the buildup of huge trade surpluses in order to accumulate US $ surpluses. 

The reality is that the value of the US $ is determined by the fact that oil is sold in US $. If the denomination changes to another currency, such as the euro, many countries would sell US $ and cause the banks to shift their reserves, as they would no longer need US $ to buy oil. This would thus weaken the US $ relative to the currency euro. The USA propagates war to protect its oil supplies, but even more importantly, to safeguard the strength of the US $. The ndamental underlying motive of the US in the Iraq war, even more than the control of the oil itself, is an attempt to preserve the US $ as the leading oil trading currency. The fear of the consequences of a weaker US $, particularly higher oil prices is seen as underlying and explaining many aspects of the US foreign policy, including the Iraq and Libyan War.

 In case of India, Since 1993, India's currency regime is said to be a managed float, a market determined exchange rate in the sense that there is a currency market and the exchange rate is not visibly administratively determined. However, RBI actively trades on the market, with the stated goal of containing volatility, and infuencing the exchange rate. Rise and fall of rupee impacts every part of society and economy. In June 2012, rupee depreciated to 56 against dollar, the lowest ever in history. 

Though India suffered lesser recession than USA, but rupee declined against dollar due to various other reasons. Developing countries like India have emerging economy, so a huge percentage of investment in India is from outside the country, especially from US but, due to recession in US big institutions collapsed and many of them stood on the verge of breakdown. To recover losses in their country, they pulled out their investments from India. Due to this pulling out of investment by these big companies from India or in other terms disinvestment, demand of dollar went up and rupee depreciated. 

The instability of international markets Eurozone is drived investors away from emerging markets which lead to fall in currencies of such countries. Other contributing factors were plunging stock markets, strengthening of the dollar, policy paralysis, rising fiscal deficit and untameable inflation, negative balance of payments with high imports etc. As India runs a large current account deficit, it needs a constant inflow of dollars, which was not there. High oil prices inflated the import bill and resulted in further widening of the current account deficit, which accelerated the rupee fall. 

For individuals, foreign travel gets expensive to the extent of the rupee fall. Overseas education, foreign tours, electronic items, goods and services imported all get expensive. In case of companies, borrowing costs surge. In general, importers lose and exporters gain. NRIs also gain through increased value of remittances. 

But India is not an export-oriented nation like Taiwan, Korea or China. Exports account for about 20% of GDP while in China, exports contribute 35%. The central bank could intervene to arrest the slide by selling foreign exchange, varying interest rates, controlling inflation. Government also could alter policies to attract foreign investments and correct economic fallacies. 

Similarly, the rise of currency also could have both negative and positive effects as when Indian rupee appreciates, exporters and IT companies begin to worry while import bills get reduced. Global uncertainties and a lot of volatility in currency markets always keeps economists guessing and with speculation abuzz, it's interesting to follow and script the course a currency takes.