Why Does The Price Of A Currency Change?

Why Does The Price Of A Currency Change?

The Foreign Exchange Market is so vast when it comes to the “did you knows”. There’s so much to learn if you want to understand what makes the Forex market tick and an excellent place to start is all the sorts of price fluctuations we see in currencies. Where do they come from? Are they deliberate or a result of something? Let’s find out.

 

Devaluation And Revaluation

As we discussed in a previous article, devaluation is the deliberate weakening of a currency’s value.  For instance, if the Euro is worth 10 units of a currency (foreign obviously) that is devalued by ten percent, one Euro is now worth only nine units of that foreign currency. (For the sake of this example let’s say the second currency is the JPY). This means that, any item bought in Japanese Yens, is more expensive for those who have Euros, as the exchange rate was lowered.

 

But that’s not the only possible scenario. An inverse change in value can also happen, but instead of weakening the value of a foreign currency, raising it – this is most commonly referred to as revaluation as we have also discussed in the article linked above. While it may seem that intentionally fine-tuning the value of a nation’s currency is “dishonest”, there are laws in place to stop the manipulation of exchange rates for such reasons.

 

Now the next question is, what happens when the value of a foreign currency doesn’t change as a result of a deliberate action? What happens when it changes as a result of market fluctuations rather than meaningful decreases or increases by a federal bank or government?  What kind of effect do these price fluctuations have then and what are they called?

 

Appreciation And Depreciation

Depreciation is easily relatable to the life of a car.  You buy a brand-new car but as soon as you drive it off the lot, its value is immediately drops to about half. This is called extreme depreciation. In the coming years, that same car will continue to lose value, but at a more steady and gradual pace. This is also known as depreciation but is more related to the passing of time and wear and tear.

 

Currency appreciation and depreciation are deviations in the value of a currency. They are mostly driven by market forces such as economic events and political announcements, rather than by government monetary policies. Do you have time for a quick trip in history?

 

Back in 1998, In an attempt to repay specific loans, the Central Bank of Russia declared the coming devaluation of the Ruble. As a result, the exchange rate, which was currently 6 Rubles for 1 US Dollar, would for the agreed period of time change to 9.5 Rubles for 1 Dollar, effectively meaning the Ruble would be depreciating by 34%. Before this change took place, there was a prevalent panic in Russia, and the value of the Ruble had already dropped because too many people wanted to trade in their securities before they had fully matured. In a ONE day, following the official announcement that the Russian government was looking to decrease the value of the national currency, the Ruble fell by an astonishing 25%. The same kind of scenario was seen again in the 1920’s when the US. stock market crashed. In that time, a national panic had set in, with people rushing to the banks to withdraw their money, which of course was not available for withdrawing. Now this may seem counter-intuitive, but in running to the bank, people actually further propelled the crash rather than escape it (as they thought they were doing).

 

Now there’s another side to this coin as you have correctly assumed. Appreciation can also be related to a vehicle just as depreciation can. Often, many men like to take old cars and restore them to their original beauty.  In doing so; they considerably push the value of the vehicle upward or appreciate it. Too quick of an appreciation (a currency’s value rising a result of economic events or political announcements) could set a country up for the, not so good kind of inflation, or at least induce an irregular increase in the retail pricing of the nation’s products. While inflation is unavoidable, it can be controlled through the correct implementation of currency valuation.

 

There you have it. The basics of what currency price fluctuations are, where they can be traced back to and what measures have been taken to try and avoid economic catastrophes. This should give you a more comprehensive idea of what makes for each tick upwards or downwards.

 

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Disclaimer:

This article is for educational and informative purposes only and should not be considered as investment or trading advice.

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