Having A Strong Currency Is Not A Signifier Of A Healthy And Growing Economy

Policymakers can struggle to know how much significance to place on a strong currency, and for good reason

12Feb

A strong currency may seem to be good for a nation, but what’s the reality? Does it improve market prices? Does it facilitate amicable export rates? Does it contribute to an expanding economy of a nation? In reality, a strong currency can be quite challenging for any nation’s policymakers. It might have its benefits, but a nation’s prosperity also depends on its export and import relationships with other nations. Therefore, a robust currency will always create a rather confounding situation for policymakers who will have to create new policies to facilitate higher export rates.

What is the hot potato effect in the global economy?

Think of it this way – when a nation has a higher currency value, its indigenous goods and services will be costlier than those the consumers can buy from foreign countries. That is one of the top reasons the USA outsources a plethora of business process related work to third world countries. At the same time, compared to other countries, USA's goods and services are costlier. Foreign buyers can find this more expensive and cut back on their imports. The flow of foreign currency depends on the exports directly, and a drastic decrease can make market growth harder. You could say the country with the stronger currency can face economic headwinds.

This is a classic example of the hot potato effect. This affects only tangible resources, non-financial instruments, consumables and financial assets of the Central Bank Reserves. The moment the market policies only involve non-consumer goods, the modern finance effect replaces the hot potato effect. To understand more about the effects of a strong currency on a country’s economy consult Zulutrade review.

The USA made plans to turn around quickly

After the global financial crisis of 2007-2009, central banks of some countries adopted aggressive monetary policies to foster a higher rate of market expansion. The time following the economic depression saw some of the lowest interest rates on debts and loans in the common market. The same financial institutions also bought assets worth trillions of dollars. The Federal Reserve utilized three distinct bond-purchase plans that came to an end in October 2014. The Federal Reserve also stopped introducing new currency into their main reserve since the economy of the country grew at a faster pace compared to other economies (of developed nations).

Bank of Japan’s plans and policies backfired

Contrary to the Fed, Bank of Japan kept up the purchases of bonds even after 2014. Back in July 2016, Japan declared that Bank of Japan would not only buy corporate bonds and government bonds (fixed income securities), but it will also leverage equity-traded funds. They intended to step up their fund investment from 3.3 trillion to a whopping 6 trillion yen. The policymakers of the country were gravely disgruntled when the market participants pushed the value of Yen higher than relative major currencies including the Dollar. This again had a negative effect on the export rates of Japan.

Bank of Australia made a smart move

After the announcement by Bank of Japan, other banks responded by lowering their interest rates to record lows. For example – the Reserve Bank of Australia introduced a record low-interest rate of 1.5% in August 2016. This was a very smart move on the part of the Reserve Bank of Australia to dampen the increasing value of the Australian dollar. They fended off the hot potato effect in a very effective manner by simply restricting the value of their currency.

Bank of England made the right decision too

The Bank of England closely followed suit. Their next change of monetary policy came in August 2016 as well. Their main intention was to allay and withstand any headwind that arose as a result of Brexit. The Bank of England actively increased their quantitative easing, and they lowered their interest rates drastically. They even invested over 100 billion Pounds in improving lending. That was a smart decision since the UK economy has grown at the slowest rate in the last five years and UK's economy expanded by only half a percent in the final quarter of 2017. However, unemployment is at a record low, real estate prices have dropped, and Britain has avoided the recession. That was possible due to the collaborative decision making during the monetary policymaking process.

What did Europe have to say?

This saw the rise of new policies from the likes of the European Central Bank. The president of the European Central Bank, Mario Draghi stated that all financial institutions should converge their monetary policies. Essentially, the expansionary monetary policy is only possible when the central banks of different nations are working in cahoots to streamline their policies.

Do we notice a certain interdependence?

The quick reaction to reduce the value of different currencies on the part of the several central banks of the several nations showed that the monetary policies of these countries are strongly interdependent. Unstable and diverging policies can always destabilize the foreign exchange market, and they can impact the flow of money from foreign nations. What each country needs in the hour of skyrocketing currency value is a shared diagnosis that can pinpoint the same cause. Unless countries and their central banks make a shared commitment to address the problem of rising currency values, another global crisis could be unavoidable shortly.

What’s the conclusion?

Having a robust currency or a strong dollar can always result in difficult challenges for policymakers of the nation. The monetary policies should facilitate the easy growth of the nation's economy and export opportunities. The country's goods and services should not become so expensive that merchants, investors and, common people find it easier to invest in foreign country services and goods. This will result in the drainage of the economy or a strong headwind. These are especially grave challenges in times of economic weaknesses, and is one of the main reasons most developed nations dread the idea of having a strong currency.

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