Foreign exchange: what entrepreneurs need to know about currencies
Exchange rate changes may have a significant impact on a country’s economy. If a nation’s currency is upgraded, the price rises as a consequence. If there is a devaluation, the currency’s price in the foreign exchange market drops.
What happens in the course of an appreciation?
Appreciation of a currency is good for import, but bad for domestic tourism and export. In the revaluation, it comes to increasing the monetary value of the country.
But what would an increase in the value of money mean for a nation’s companies? Exports will become more expensive, foreign tourists would need to dig deeper, but imports will become cheaper. If one dollar costs one euro, for example, with the euro revalued by 20 per cent, the euro would subsequently cost $1.20.
Let’s take Germany as an example. The American importer will now have to pay $20 more if he buys goods worth of $100 from Germany. In the same breath, imports will become cheaper. So if goods in the US cost $100, the German entrepreneur would have to pay only $83.33.
Due to the fact that commodities are all traded in US dollars, consumers can also look forward to cheaper prices.
The devaluation
Currency devaluation is bad for imports, but good for tourism and exports. A devaluation occurs when a nation’s currency loses value compared to foreign currency. Importers will have to pay higher prices, while exporters will save money. This is exactly opposite to what happens during appreciation.
For example, let’s say the euro was currently trading at $1.20. If the same goods were to cost $100, it would now cost $120 because of devaluation. If parity is reached due to devaluation, the goods would continue to cost $100.
However, import costs are rising. Exporters can look forward to sales increases but importers must expect sales losses at the same time.
The key interest rate also has an impact
The so-called exchange rate systems also play a key role. Due to the fact that currencies are traded on the foreign exchange market, the supply and demand principle applies. If supply exceeds demand, the exchange rate will fall. However, if demand is greater, the value of the currency will rise. As a rule, the players are major international investors: institutional investors, insurance companies, major banks and private investors.
Sometimes Central Banks can also influence currencies. Changes in the key interest rate can impact a nation’s currency. The level of the prime rate is the fee that banks have to pay when they ask the central bank for money.
If the key interest rate is high, banks hesitate. After all, they have to charge consumers even higher interest rates, so that the bank can earn some of the credit. High interest rates can thus prevent high inflation.
