Currency Exchange Rates And How They Are Influenced

A country's financial health can be determined not only by its inflation and interest rates, but also through its currency exchange rates which determines its strength in the international foreign exchange market. Currency exchange rates are probably one of the most analyzed and observed parameters in the financial world as a country's level of international trade is determined by the exchange rate of the nation. However, it is not just international trade, but also people who are trading in the stock market who get affected by constant movements in the exchange rates.

In cases of international trade, a country with a stronger or higher currency finds its imports cheap and exports expensive, thereby reaping profits for the country. A lower currency would be the opposite with expensive imports and cheap exports.

The factors that determine exchange rates are numerous and one among them is the bilateral relationship between two trading countries. A country with lower inflation rates most probably has a higher currency as the purchasing power of the currency in relation to the other currencies increases. The reasons why countries like Japan, Germany, Switzerland, the UK, the US, and Canada dominated the second half of the twentieth century is because of the low inflation rates they observed within their economies. Countries with depreciated exchange rate values have always paid a higher price during international trades.

Exchange rates are highly correlated with interest and inflation rates. A country's volatile interest rates always have an impact on its currency and inflation values. Central banks of different countries try to manipulate interest rates so as to achieve and maintain a favorable inflation and exchange rate.

National governments usually engage in borrowing money from their citizens for various public sector projects and funding for other government expenses. Such large scale financing does strengthen a country's domestic economy, but it mostly keeps away foreign individual and institutional investors. The reason being countries with larger internal debt usually see a rise in inflation rates. And if the government starts printing money to pay off its debts, then it would result in higher circulation of money, thereby causing inflation to go up even further.

If a country cannot raise money through internal financing, then it would most likely indulge in increasing its security supply to foreign parties at a cheaper rate. Foreigners who are aware of the country's internal debt would mostly be wary and would not like the securities to be denominated in the security supplying country's currency. Debt rating given by credit rating companies is imperative in determining a country's financial health, which is also a major determinant of currency exchange rates.

By: Jeremy C. Winters

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