Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by numerous fundamental and technical factors. These include relative supply and demand of the two currencies, economic performance, outlook for inflation , interest rate differentials , capital flows, technical support and resistance levels, and so on.

As these factors are generally in a state of perpetual flux, currency values fluctuate from one moment to the next.

Explained: Bretton Woods Fixed Exchange Rate & Reforms

In this situation, a currency becomes the tail that wags the dog, in a manner of speaking. For the typical consumer, exchange rates only come into focus for occasional activities or transactions such as foreign travel, import payments or overseas remittances.

The Effects Of Currency Fluctuations On The Economy | Investopedia

A common fallacy that most people harbor is that a strong domestic currency is a good thing, because it makes it cheaper to travel to Europe, for example, or to pay for an imported product. In reality, though, an unduly strong currency can exert a significant drag on the underlying economy over the long term, as entire industries are rendered uncompetitive and thousands of jobs are lost. And while consumers may disdain a weaker domestic currency because it makes cross-border shopping and overseas travel more expensive, a weak currency can actually result in more economic benefits.

Directly or indirectly, therefore, currency levels affect a number of key economic variables. They may play a role in the interest rate you pay on your mortgage, the returns on your investment portfolio, the price of groceries in your local supermarket, and even your job prospects.

A simple example will illustrate this concept. Assume you are a U. The cost to your European buyer was therefore EUR 8 per widget. Your buyer is now negotiating a better price for a large order, and because the dollar has declined to 1.

Even if your new price is EUR 7. The depreciation in your domestic currency is the primary reason why your export business has remained competitive in international markets. Conversely, a significantly 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, industry sectors that are highly export-oriented can be decimated by an unduly strong currency.

What is currency fluctuations? Definition and meaning - cozosen.web.fc2.com

As discussed earlier, net exports have an inverse correlation with the strength of the domestic currency. Foreign capital will tend to flow into countries that have strong governments, dynamic economies and stable currencies.

A nation needs to have a relatively stable currency to attract investment capital from foreign investors. Otherwise, the prospect of exchange losses inflicted by currency depreciation may deter overseas investors. Capital flows can be classified into two main types — foreign direct investment FDI , in which foreign investors take stakes in existing companies or build new facilities overseas; and foreign portfolio investment , where foreign investors invest in overseas securities.

FDI is a critical source of funding for growing economies such as China and India, whose growth would be constrained if capital was unavailable. As mentioned earlier, the exchange rate level is a key consideration for most central banks when setting monetary policy. For example, former Bank of Canada Governor Mark Carney said in a September speech that the bank takes the exchange rate of the Canadian dollar into account in setting monetary policy.

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

Despite such enormous trading volumes, currencies stay off the front pages most of the time. However, there are times when currencies move in dramatic fashion; during such times, the reverberations of these moves can be literally felt around the world. We list below a few such examples:. How can an investor benefit? Here are some suggestions to benefit from currency moves:. Conclusion Currency moves can have a wide-ranging impact not just on a domestic economy, but also on the global one.

Investors can use such moves to their advantage by investing overseas or in U. Because currency moves can be a potent risk when one has a large forex exposure, it may be best to hedge this risk through the many hedging instruments available. Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund.

Latest Videos PeerStreet Offers New Way to Bet on Housing New to Buying Bitcoin? This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education.

The Effects Of Currency Fluctuations On The Economy By Investopedia Staff Share. We list below a few such examples: The Asian crisis of — A prime example of the havoc that can be wreaked on an economy by adverse currency moves, the Asian crisis began with the devaluation of the Thai baht in July This triggered a financial collapse that spread like wildfire to the neighboring economies of Indonesia, Malaysia, South Korea and Hong Kong. The currency contagion led to a severe contraction in these economies as bankruptcies soared and stock markets plunged.

China held its yuan steady for a decade from to , enabling its export juggernaut to gather tremendous momentum from an undervalued currency. This prompted a growing chorus of complaints from the U. China has since allowed the yuan to appreciate at a modest pace, from over 8 to the dollar in to just over 6 in The Japanese yen has been one of the most volatile currencies in the five years to mid Here are some suggestions to benefit from currency moves: If you are a U.

Consider the example of the Canadian benchmark index — the TSX Composite — in the first decade of this millennium. But the steep appreciation of the Canadian dollar versus the U.

Refrain from borrowing in low-interest foreign currencies: This is admittedly not a pressing issue from onward, since U. But at some point U.

At such times, investors who are tempted to borrow in foreign currencies with lower interest rates would be well served to remember the plight of those who had to repay borrowed yen in The moral of the story — never borrow in a foreign currency if it is liable to appreciate and you do not understand or cannot hedge the exchange risk.

Adverse currency moves can significantly impact your finances, especially if you have substantial forex exposure. But plenty of choices are available to hedge currency risk , from currency futures and forwards, to currency options and exchange-traded funds such as the Euro Currency Trust FXE and CurrencyShares Japanese Yen Trust FXY.

If your currency risk is large enough to keep you awake at nights, consider hedging this risk. In a manner of speaking, the currency becomes the tail that wags the dog. Exchange rates have a tremendous influence on the economy. Exchange rates can indirectly affect many of the most important aspects of our lives.

Currency fluctuation financial definition of Currency fluctuation

Currency fluctuations often defy logic. Learn the trends and factors that result in these movements. We look at what a currency war is, what factors may lead to it, the impacts of such a strategy, and whether there is a currency war currently. A variety of factors contribute to currency depreciation, including monetary policy, inflation, demand for currency, economic growth and export prices. The value of a country's currency is dependent on many factors that will cause it to fluctuate, relative to other world currencies.

Central banks and financial institutions hold large amounts of foreign money as their reserve currency. International currency exchange rates display how much one unit of a currency can be exchanged for another currency.

Read about the causes of currency devaluation, and find out how to differentiate between relative and absolute currency devaluation. Exchange rates float freely against one another, which means they are in constant fluctuation. Currency valuations are determined Generally, higher interest rates increase the value of a given country's currency, but Interest rates alone do not determine An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.

A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other.

A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money. Content Library Articles Terms Videos Guides Slideshows FAQs Calculators Chart Advisor Stock Analysis Stock Simulator FXtrader Exam Prep Quizzer Net Worth Calculator. Work With Investopedia About Us Advertise With Us Write For Us Contact Us Careers.

Get Free Newsletters Newsletters. All Rights Reserved Terms Of Use Privacy Policy.