Last updated on February 10th, 2019 at 04:41 am
The ebb and flow of currency is a natural effect of the floating exchange rate structure that is the average for most big economies. The rate of exchange from one currency versus another is significantly influenced by many technical and fundamental factors. These factors include comparative demand and supply of both currencies, the outlook for inflation, capital flows, interest rate differentials, economic performance, resistance, and technical support levels, and many others. Since these factors are always in a perpetual influx state, the values of currency fluctuate from time to time.
Effects of exchange rates fluctuations on businesses:
1. Prices of Commodities
Most of the commodities are typically priced in U.S Dollars, meaning a change in the dollar exchange rate will directly affect the price of commodities such as foodstuff and oil. An increase in the value of the U.S Dollar would mean that, for foreign countries, it would cost more of their own currency to pay for raw material.
This, in turn, would cause businesses to spend more money on producing goods and services. So, in order to make profit, those businesses would have to charge more for every unit they produce, to cover increased production costs.
On the other hand, if the U.S currency was to drop in value, foreign businesses would find that raw material, as well as, oil, would cost them even less that they normally spend. Such a decrease in production value can cause companies to decrease their prices; a technique which has potential to generate more profit than if prices were to be kept the same. It all goes back to demand and supply principles; a low price can trigger an increased demand, which would result in profit, if the supply is elastic enough.
2. Changes in the Rates of Imported Services and Goods
This change will have a direct impact on the customer price index. For instance, an exchange rate appreciation will reduce the prices of imported consumer durables and goods, capital goods and raw materials.
In simpler terms, if your national currency’s value increases relative to other currencies, your business won’t have to spend a lot of money when importing goods from other countries. Most businesses consider such an event, an opportunity to import as much raw material as possible.
On the contrary, if a currency drops, the price for imports automatically increases. Why? Simply, because if you were an American retail business that used to pay $1 for an imported shirt, a drop in your currency’s value would mean that you would need to pay $2 for that same shirt. During times like these, businesses tend to import less goods and services.
3. Changes in Exports GrowthA higher exchange rate makes it a lot more difficult to sell overseas due to a rise in similar prices. If exports slowdown, then the exporters might decide to reduce output level, cut back employment levels and cut their prices.
According to currency-convertor.uk, a depreciation of 10% in exchange rates can add a maximum of 3% to consumer prices level three years after the first change in the rates of exchange. However, the effect of inflation of a variation in the rate of exchange depends on other things happening in the economy.
For people who know their way around economics and the basic terms, the latter will make total sense. However, if this sounds like total gibberish to you, there is no need to worry. Here’s a breakdown of the past two paragraphs.
We have already covered that an increase in your national currency exchange rates would result in cheaper imports. Consequently, this means that other countries would have to pay more for whatever your business offers. An increase in the price of exports would mean that, in general, national businesses would be earning more.
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As for the opposite scenario where a currency’s exchange rate depreciates, you can probably predict what is going to take place. Export prices would plummet because what once cost a certain amount, would now be costing much less, because the currency used in trade has decreased in value. So, what does this mean for businesses that depend on exporting? They may be losing money if they need to import their raw material; but, if they don’t, and they manage to cater to an increased demand, they may end up making a profit. It’s all because foreign business benefiting from price reductions would try to capitalize and buy huge amounts.
One thing that you should keep in mind is that whether a business makes a profit or not, depends on the type of goods, or services they provide. Some products are expendable so, when prices go too high, the demand will most probably decrease, as well. However, for other commodities; flour, for example, demand is most likely to stay the same through various exchange rates because flour is an essential material.
Exchange Rates and Unemployment
- An appreciation in the exchange rate causes a slower growth of GDP due to a fall in the net exports and a rise in import demand which is an increased seepage in the entire flow.
- Some businesses are more exposed to currency fluctuations than others, for example, sectors where the demand is price sensitive and where a significant percentage of the total output gets exported.
- A reduction in output and demand may lead to the loss of jobs as businesses try to control their costs. However, some of these job losses may be temporary since they reflect the short term variations in import penetration and export demand. Others may be permanent if the imports cover a permanently greater share of the local market. Therefore a high rate of exchange can have a tremendous negative multiplier impact on the economy.
In a nutshell, a cheaper currency will provide a competitive advantage to business and cause accelerator and multiplier effects in the circular flow of spending and income. Deprecation, on the other hand, has the effect of growing the income and value of profits for the businesses of a country with investments overseas. However, some of the benefits of a weak currency occur in the short term, but there are some potential benefits in the medium term as well.