Economy and the currencies
The economic state of a country has a significant effect on its consumers. Consumers are more confident and safe with countries with stronger economies, and they are more than willing to pay if this is the case.
Incoming money is positive news for the government since it makes more revenue. It creates a ripple effect to others, making them willing to spend money, hence strengthening the economy more.
However, if the economy is weak, the government is the only one who will spend, and the others, including the consumers and businesses, will not. If you are thinking why we are talking about this, it’s because the economy has a lot to say about the currency markets.
A term called GDP or gross domestic product can measure how strong the economy is. It stands for all monetary value for every goods and service produced and sold within a country in a given time frame, usually in a year.
Global advancement has made investing easier regardless of location. Technology has made it possible to invest in different stock exchanges or trade foreign currencies. Here, “capital flows” enter the picture. Capital flows refer to how much money flows in and out of the country or economy from capital investment buying and selling. Its balance can be positive or negative. If it’s positive, it means foreign investments coming in are more than what’s coming out, and it’s the opposite when it’s negative. More investments mean more currency demand because foreigners sell theirs while they buy that local currency. Now that we have come to this, high supply means low demand and value.
Trade flow and balance
International trade is more of the trade of goods and services where services have a fair lower share. In fact, goods trade has become more prominent in the past ten years, from $10 trillion to $18.99 trillion in 2019. Countries export their goods and import goods from other countries. Furthermore, import-export and buying and selling involve money exchange that impacts a country’s currency flow.
Here is where trade balance enters the picture. It gauges the import-export ratio of an economy. It also tells us a lot about the demand for a country’s goods, services, and even currency. Higher exports than imports mean positive balance and trade surplus, while higher imports than exports mean negative trade balance and trade deficit. When there is a trade deficit, it can decrease the currency’s value against the others.
Net importers and exporters
To buy the foreign currency that sells the goods that the net importer prefers, they need to sell their currency first. That means a country with a trade deficit has lesser demand than a country with a trade surplus. If there are net importers, then there are also net exporters. If a country has higher exports than imports, their currency has many buyers since many are interested in buying their exported goods. More demand means more currency value. Trade surpluses are prone to currency appreciation.
Finishing with some trivia
These are only few elements that impact fundamental analysis. Let us end today’s lesson with some trivia. Did you know? The US has the largest economy, while China places second. Both of them contribute to more or less 40% of the world’s GDP. The highest 15 economies stand for 75% of the world’s total GDP.