The information presented here is designed for the Forex/currency trader. This information is also useful to anyone who would like to develop an understanding of factors which determine currency value. For the currency trader, this understanding is needed in order to develop a currency trend analysis for a particular country. Developing accurate currency trends is the key to successful Forex trading.
What determines the value of a countries currency really comes down to supply and demand of that currency. If a particular countries currency is in high demand by purchasers such as travelers, governments, and investors, this will increase the value of the countries currency. The factors that follow may have a positive or negative affect on the demand for a particular currency. Lets take a look at these factors.
1) Printing of Currency:
If a country prints an excessive amount of currency, more then what it normally would, this can decrease the value of the currency. Any time you have more of anything, this can result in a decrease in it's value. This is true whether you are talking about currency or commodities such as iron ore, crude oil, coal, gold, silver and platinum. A large amount of currency in circulation can lower the value of a currency. A small amount of currency in circulation can result in the value of the currency increasing.
2) Current State of the Economy:
If a countries economy is not doing well, this can decrease the demand for that countries currency. Specifically, here we are talking about the degree of unemployment, degree of consumer spending, and extent of business expansion that is taking place in a country. High unemployment, decrease consumer spending, with a decrease in business expansion, means a poor economy and a decrease in currency value.
The potential for economic growth in a country should also be looked at. If the potential is strong, then it's currency value would expect to increase. Also, if a country produces products that other countries want to buy, this can increase the value of that countries currency.
3) Prices of Foreign Goods:
Related to the economy, is the prices of foreign goods. If a foreign company sells goods in a country which are cheaper then comparable products produced in that country, this can hurt the economy of that country. A poor economy results in a decrease in demand for that countries currency, which lowers it's value.
4) Political Conditions of a Country:
To what degree does political corruption exist within a country? To what degree do political affairs have on the economy of that country? A country which is known to have corrupt politicians, can result in a lowering of the value of it's currency.
5) How Secretive is a Country:
A country which operates at a high level of secrecy, at least as observed by those outside the country, can result in a lowering of the value of their currency. Another words, if not much is known about a country due to a restriction of media expression within that country, this can lower the value of it's currency.
6) National Debt of a Country:
To what degree are politicians addressing a national debt problem? Are politicians causing an increase in the national debt? In a democratic society, national debt must be paid by the taxpayer. If taxes increase, this results in a lowering of the purchasing capability of society, which results in a deleterious affect on the economy. In this case, currency value will decrease.
7) Presidents Popularity:
If a president is popular, this can increase the demand for a currency. If the presidents popularity is dropping, due to unpopular government policies, this may result in a decrease in demand for a currency and a subsequent lowering of it's value.
8) War and Terrorists Attacks:
A terrorists attack can increase the probability of a war. A war or the strong potential for a war can decrease the demand for a currency, simply because a war drains the economy. Wars are expensive and must be paid by the taxpayer. You simply can not have a growing economy during war time. So war lowers the value of a currency.
9) Government Growth:
Is government growing and expanding to much? New growth by developing departments, and creating unnecessary programs, all costs money. Again, the taxpayer will need to pay for the new growth, which for the long run has a negative affect on the economy. Excess government growth can lower the value of a countries currency.
10) Tax Cuts for the Consumer:
Tax cuts can stimulate the economy, as long as the consumer spends the extra money he or she may have. But also, tax cuts which are to large can result in high demand for products, which may raise prices, which can lead to inflation and the desire to purchase cheaper foreign products. But in general, tax cuts historically have been good for the economy, which can result in an increase demand for that countries currency.
11) Interest Rates:
A higher interest rate means a higher demand for a currency. Foreign investors in a currency prefer a higher interest. It is the same principle when you shop around for the highest interest rate when putting money into a savings account. This increase in demand for a currency results in an increase in it's value.
12) Housing Market:
If there is a slowing of a housing market, this means the sellers asking price will be less, and with the realization that a persons home is worth less, this results in less consumer spending. This has a negative affect on the economy. Again, poor economic conditions result in a lower demand for the currency, thereby lowering it's value.
13) Positive or Negative Perception:
How purchasers of a currency perceive the previous discussed parameters, can determine the degree of demand for a currency. Whether or not the perception is accurate or not is not as important as what the perception itself is. Perception is what determines if a currency purchaser decides to buy or sell a currency.
To conclude, the factors presented here are determinants of the degree of demand on a currency, and therefore it's value. There are other factors such as manufacturing growth, degree of entrepreneurship in a country, employment growth, and even the weather and it's affect on the agricultural industry, energy consumption, and local economies. These also can determine the demand for a currency. The factors listed here determine the perception that a potential buyer of currency may have. And here, perception means everything. How a potential buyer of a currency looks at a particular country using these parameters, will determine the demand on the currency, and ultimately it's value.
With this understanding, it is not difficult to see why the value of the US dollar has dropped so much lately. This is mainly due to a sky rocketing federal deficit, the lack of the current administration's desire to reduce the federal deficit, enormous government growth, the fed's high level of money printing, a slow housing market, a decrease in the President Obama's popularity, and a current poor economy which includes relatively high unemployment, all of which were previously discussed. Investors outside the United States are looking at the US dollar as to risky, which results in a decrease in demand for the US dollar, and a drop in it's value.
