Daily the business press reports the valuation of various currencies and makes bold statements about various currencies being over-valued or under-valued and the impact that has on trade and the economy. But most investors don’t really understand the whole currency discussion. The closest most individuals get to dealing with currencies is equating how much something costs in dollars when trying to purchase a memento (or lunch) in a foreign country.
Currency, according to Wikipedia, is the physical aspect of a country’s money supply. The government declares a certain coin or bill to have an intrinsic value to be used to pay for items or debts. When reporters and economists refer to the value of a currency, however, the foreign exchange market determines that value.
The foreign exchange market or currency market is a worldwide-decentralized over-the-counter financial market for the trading of currencies. It allows one country to convert the currency of another when paying for goods from its own country. It operates 24/7and is the largest and most liquid financial market in the world. (Wikipedia).
Clearly many factors seem to influence the value of currencies. These factors include:
- Economic policies of a specific government. For example, the United States debt will ultimately impact the value of the dollar.
- International crises and wars. The earthquake in Japan will impact the value of the yen as the turmoil in the Mideast also impacts the value of multiple currencies. Sometimes turbulence in one country increases the value of currencies that are deemed to be “safe”.
- When a country releases economic indicators such as the GDP or other productivity or sales indicators, it will impact the value of the currency.
So why do economists so frequently discuss currency issues. Because sometimes a country will try to control the value of its currency by buying and selling its own currencies. China, for example, is often accused of controlling its own currency.
For many years China maintained a fixed exchange rate. It simply made it illegal to trade its currency (the yuan) at any rate other than the one fixed by the government. In 1996 it began to allow its rate to float, in order to meet the demands of its trading partners. At the same time, China’s central bank still controls the value of the currency more frequently than other countries causing other governments to complain about its methodologies.
For example, according to the Financial Times (3-14-11), Timothy Geithner continues to assert that the Chinese undervalue their currency. What this means for an average consumer is that when China imports U.S. goods, the value of those goods is still too expensive for the average Chinese consumer. At the same time, goods imported into the U.S. are cheaper than they would be if there currencies were balanced.
Currencies will continue to challenge our economies in a developing world. Emerging countries will try harder to control their currencies than those of the developing world. Therefore, as investors listen to and read about currency changes, they should realize that there is more at stake than how much your next cup of coffee in France will cost.