The Effects of Foreign Exchange Fluctuations

by Walter Johnson

Forecasting and planning for alterations in the value of currencies relative to one another is one of the more esoteric economic topics. There is no surefire way to plan this to perfection, since many exchange rate changes happen rapidly and for myriad causes. However, if your customers in Britain are being charged in dollars, then the alteration of the value of the Euro can permit your competition to undercut your prices.

Currency Spikes

If the dollar were to suddenly spike in value rapidly, several things would happen quickly. The dollar, now worth more, would be seen as a worthwhile investment. The demand for dollars would increase and investor confidence in the American economy would do likewise. American exports abroad would become more expensive, and articles imported into the U.S. would be relatively cheaper by comparison. American firms getting their supplies in the Chinese Yuan would have an automatic competitive advantage against those firms completely located in America.

Currency Drops

If the dollar were to suddenly fall in value, several very different things would happen quickly. America's foreign competition would have grave doubts about American solvency and may even consider dumping dollars on the market. Inflation could increase if this drop in value were not matched by increases in production and general economic activity. If the dollar falls in value, so do wages, debts and the cost of doing business in general. In severe situations, a sudden drop in a currency already under pressure from massive debt could cause a panic, where investors would quickly want to pull their money from American investments, bonds and banks. It could, under such conditions, bring a deep depression.

Currency Volatility

A common economic phrase is that currency volatility automatically increases the cost of doing international business. Volatility implies instability in the domestic market situation or an incompetent central banking system. It also implies investor uncertainty, which in turn, could lead to local divestment. Many international firms have different currencies in reserve in case of any sudden changes. At the same time, many firms also want to spread risk over several currencies, doing business under many different local currencies as a "hedge" against any sudden movement. This, however, is a substantial cost of doing international business and is inherently a part of currency volatility and fluctuation.

Currency Values

Currency values are an important way to gain competitive advantages in global business. If profits can be marked in a powerful currency but debts in a weak one, the firm is doing very well. This is always the goal but cannot be predicted with any certainty. Nevertheless, firms and state banks often have many reserve currencies in their possession to make the best of international opportunities. Quick profits can be made when a currency suddenly spikes in value.

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