Currencies are like any other commodity, they are used and traded either for speculation, investment or as a medium of exchange. Currencies rise and fall because of basic supply and demand. Speculation, investments or economic activity all contribute to it.
A country's currency does not always mirror economic conditions, a country may have a very robust economy but its currency may remain weak relative to other currencies. A weak economy can also deliver a strong currency depending on current factors but how is it done? The answer lies in speculation, everyday, currencies are traded against each other relying mostly on technical factors than its fundamentals. If a currency's value drifts far away from a country's economic objectives, whether it has become too weak or too strong as a result of free market trading, the government steps in and artificially rebalances supply and demand.
A currency that is weakening means that there is too much supply in the market, a governing body can attempt to reverse this by making their currency a lot more expensive to acquire such as raising interest rates which in turn makes the currency harder to borrow. This move can either work or not because a higher interest rate also weakens economic activity that may further push the currency lower.
A strengthening currency can be reversed through government intervention by flooding the market with more currency. This is done by decreasing interest rates or issuing new government bonds. This strategy has a higher success rate than attempting to strenghten it because these tactics contribute to inflation which makes a currency fall in value very fast. However, depending on the interpretation of the speculating herd, a weaker currency means cheaper export prices which can increase the demand for the currency. Currencies rise and fall in value because of multiple factors that can be interpreted differently by traders, investors or the government.
Factors affecting currency movement:
- Importing countries need to convert their local currency into the currency where the imported goods originated for payment.
- Government intervention.
- Speculation in the foreign exchange market. This includes the inflation rate, economic activity or merely the momentum of the currency's trading activity.