Currencies are also subject to the
law of supply and demand, the greater the demand for a currency the higher it's
value would be. Currencies reflect the health of a country's economy,
heavy consumer spending generates high revenues for businesses and thus creates
high demand for money. An increase in transactions using a particular currency
may cause inflation to spike rapidly, a higher interest rate prevents this by
enticing other people to hold the money in exchange for a high return. When
bought in huge numbers because of a high interest rate, the currency would increase
further in value. This would be the base for all huge buyers of currencies such
as banks, big daddy speculators or central banks to keep huge reserves of a
country's currency to profit from the rise in value. Thus the reason for the
fluctuation of a country's currency in relation to another is the demand from
either the increase of transactions or speculators buying huge amounts for profit.
A central bank could strengthen the value of its currency by buying its own
in exchange for another currency or devaluing by selling huge amounts of it.
For instance when central banks around the world buys US dollars as reserves,
this boosts the value of the US dollar because of these huge "buy orders".
In return, if they sold their own currency for the US dollars they have in reserves,
this creates an excess flood of their own currency in the market. When there
are not enough buyers for it, it is likely that its value would be less per
unit than the highest currency in demand at the time.
When business transactions increase in Canada for instance, this would lead
to the chain of events causing huge buyers or speculators to demand the Canadian
dollar against another currency. Lets assume it is the US dollar, and the central
bank buying the Canadian dollar has huge reserves of the US dollar. Once it
executes the transaction in high volume, tides would turn for the US dollar
as it is now heavily sold in exchange for the Canadian Dollar. A continued decline
in the US dollar may signify that other huge institutions that once held huge
reserves of the US dollar are now dumping it, flooding the market in exchange
for another asset.
A country with high political tensions scares away investors or businesses in
the country. Without these components people would have a hard time looking
for a job, which means they are plain broke. No money to spend, not much revenues
for businesses therefore the resonance of its currency in the international
market is so faint that only a few people would want to buy or hold it. The
risk of a sharp decline in that currency cannot be supported if there are no
huge buyers for it which creates demand.