Its all about 'Money'!

A penny saved is a penny earned! – Benjamin Franklin

Everyone is concerned about currency fluctuations and it only makes sense in this ever-changing world. I am part of the most dynamic markets at this point in time, thanks to Brexit. With continuous drop in the value of GBP and Euro hand-in-hand, it only laid a logical path for me to write about “what is currency fluctuation all about?”

But firstly, did you know that (from multiple sources):
  • There are 180 currencies in the world in circulation recognised by the UN
  • Paper money was originally introduced by China during Tang dynasty (618-907) as a medium of exchange
  • In Europe, it was introduced by Sweden back in 1661
  • The first Indian ‘rupee’ is believed to have been introduced by Sher Shah Suri (1486-1545)
  • In 1987, ₹500 note was introduced in India with the portrait of Mahatma Gandhi and the Ashoka Pillar watermark
  • In 1978, all high-denomination banknotes (₹1000, ₹5000, and ₹10,000) were demonetised to curb unaccounted money in India

We all know that, in modern times, currency is the definitive answer to exchange anything in the world. These days, digital currency is prevailing at a faster pace and is one of the most talked about topics of the times. Here is an interesting article on Bitcoins. The article also talks about dark web and silk road which would certainly give you a perspective on the other side of digitising the

So now there are numerous countries and each one has its own currency (sometimes same currency is followed in many like Euro or USD). How are these currencies valued? Pegging is an important term used in the currency markets, wherein a currency is fixed against another currency, basket of currencies or any other measure such as gold. In the 19th century and early 20th century, many countries followed gold standard. The US abandoned gold standard in 1933 and completely served the link between the dollar and gold in 1971. As of today, US dollars are fully backed by the US government and not to any commodity.

USD is the world's most heavily traded and widely held currency followed by Euro. Large portions of global central banks’ reserves are held in US dollars and are used to settle international transactions. Additionally, commodities such as gold, oil etc. are transacted in USD. Hence, any major political, economic or financial event in the US will have a spiraling effect across the globe.

While USD is the currency of a single country, Euro is the single currency for whole of Eurozone. Weakening of Euro is directly related to the incidents within the Eurozone countries both politically and economically (incl. capital markets). In the recent times, Euro had experienced significant fluctuations due to Brexit and plausibility of the populist victory in the French elections. Although there is some stability in Europe now with the centrist, Emmanuel Macron, winning the French elections, time will only tell the tale of how soon-to-be-held German elections and Brexit negotiations would shape the future of Euro.

Coming back to how currency impacts an economy, let me take you to the basic economics class and its renowned formula: GDP = C + I + G + (X - M).
  • C – Consumer spending
  • I – Country’s investment
  • G – Government spending
  • (X – M) - exports minus imports or net exports

Clearly, a country’s GDP is directly correlated to its net exports. A relatively higher value of a local currency makes the imports cheaper for the country. For example, if USD/INR rate increases, it would increase the imports for the US because for the same value of dollar they are able to buy more. And the converse is true as well. It is essential to maintain a stable currency, balanced supply and demand, in order to have a sustainable GDP growth.

As per Central Intelligence Agency, list of countries with current account balance surplus for 2015 has been ranked as below:
  1. China
  2. Germany
  3. Japan
  4. South Korea
  5. The Netherlands

And the list of countries with current account balance deficit for 2015 has been ranked as below:
  1. United States
  2. United Kingdom
  3. Brazil
  4. Australia
  5. Canada

India was ranked 10 under current account balance deficit in 2015 and 7 in 2016.

While on currency, it is important to understand if devaluation is good for a country? - A country could potentially devaluate its currency to stabilise trade imbalances. When a currency gets devalued, its goods and services become cheaper making them more competitive in the global markets. However, a currency crisis occurs when there is a serious question around a country’s central bank to maintain its exchange rate with its reserves in store.

Additionally, devaluation creates inflationary pressures within the country because of higher import prices. These inflationary pressures sometimes get uncontrollable resulting into hyperinflation, losing the value of real money. A grave example of hyperinflation comes from Deutschland after world war I when the exchange rate of German mark to US dollar was about 4.2 trillion to one between 1921 and 1924.

Finally, currency has become an integral part of the human life and for the living. ‘Made in China’, ‘Made in Thailand’, ‘Made in Germany’ are the products found in the remotest parts of the world these days. Currency fluctuation is no more a concern just for the developed nations but a significant and impactful aspect for every nook and corner of the planet.

My advice - Beware and Be frugal ;-)

1 comment:

Soumya said...

Quite a research you did. Very informative 👏

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