Fluctuations in exchange rates refer to the changes in the value of one currency relative to another over time. When the demand for a currency exceeds the available supply, the currency becomes more valuable. When demand exceeds available supply, it becomes less valuable. Exchange rates are determined by various factors, such as supply and demand, interest rates, inflation, and geopolitical events. When any of these factors change, it can cause the exchange rate to fluctuate.
There are several reasons why exchange rates fluctuate. One of the main reasons is changes in the supply and demand of currencies. For example, if the demand for the U.S. dollar increases, its value will rise relative to other currencies, and vice versa. Similarly, if a country experiences a trade deficit, which means it is importing more goods and services than it is exporting, its currency may weaken relative to other currencies.
Increased demand for a currency can be attributed to either increased transactional or increased speculative demand for money. Transaction demand is highly correlated with a country’s level of business activity, GDP, and employment levels. The greater the number of unemployed people, the less money the general public will spend on goods and services. Central banks typically have little difficulty adjusting the available money supply to accommodate changes in the demand for money due to business transactions.
Another factor that can cause fluctuations in exchange rates is changes in interest rates. Higher interest rates typically attract more foreign investment, which can strengthen a country’s currency. Conversely, lower interest rates may lead to a weaker currency.
Inflation can also impact exchange rates. If a country’s inflation rate is higher than that of another country, its currency may weaken relative to the other country’s currency. This is because higher inflation erodes the value of a currency over time.
Central banks find it much more difficult to accommodate speculative demand, which they influence by changing interest rates. A speculator may purchase a currency if the return (interest rate) is high enough. In general, the greater the demand for a country’s currency, the higher its interest rates. It has been argued that such speculation can undermine real economic growth, particularly because large currency speculators may deliberately short a currency in order to force that central bank to buy their own currency in order to keep it stable.
Finally, geopolitical events such as wars, political instability, and natural disasters can also impact exchange rates. These events can create uncertainty and instability, leading investors to pull their money out of a country, which can cause its currency to weaken.
Fluctuations in exchange rates can have a significant impact on international trade, investment, and financial markets. Businesses that engage in international trade and investment must manage the risks associated with exchange rate fluctuations to protect their profits and investments. Central banks and governments may also intervene in currency markets to stabilize exchange rates and mitigate the impacts of fluctuations.
Exchange rates can have a significant impact on carriers shipping goods from one country to another. As a result, most carriers charge a CAF fee to account for these fluctuations.
