What Determines the Foreign Exchange Rate?
Posted by Linda | | Posted on 14:35
Money Management and Personal Finance : What Determines the Foreign Exchange Rate?
In actual practice, a currency's value is never derived solely on the basis of what a government says it should be. Instead, it is a mixture of what a government says it should be, what that government's fiscal policies are, the health of the country's economy and what people think the value of the currency should be. The latter gives rise to the practice of trading currency as if it were a commodity, and thus the foreign exchange or currency market.
So, for example, if a government is running a high, systemic deficit; has a weak economy; and is suffering a string of financial scandals, it will fall in value towards what the actors on the market perceive its real value to be. State banks, private banks, and corporations will start selling that currency for more valuable or stable currencies, and speculators will begin betting against it. The result is a dumping of the undesired currency, and a scramble to buy up other forms of money. This is exactly what happened when the US dollar went into a record, downward spiral against the Euro, Pound Sterling, and Yen in 2007 and 2008.
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