Why currencies are getting cheaper or more expensive?

You might have already heard of a rapid fall (more than 6% in a couple weeks of January) of RUB currency value against all major currencies.

This is not the worst thing you could hear from media, but what is much worse? Much worse is a massive propaganda efforts on a part of a government saying everyone that everything is fine, this currency rates mean very little, this will have no direct effect on prices, everything is under control, this could help our export-oriented industies etc.  In fact, this is not fine at all and I’m not sure you want helping oil companies at expense of purchasing power of your money. The same story with budget. Here are some considerations.

First, let’s go over a few reasons why currency could ever get go up or down in value by a lot (Foreign eXchange markets are fluctuating on a high-frequency basis, but significant moves are never caused by random buying of selling and not caused by speculation).

So here are reasons for currency to go up in value:

  • Your economy is getting more and more productive. Therefore you produce a lot more goods and services while amount of national currency in circulation is not growing rapidly. This makes this currency more valuable because people want goods and there are more goods now.
  • You have a massive foreign currency inflow in form of foreign investments or in form of money paid for goods your country exports.
  • Your economy experiences liquidity problems. For some reason people or companies try selling massive amounts in assets and there is not enough buyers for those assets. So assets start falling in price and currency automatically start appreciating. This could happen because of many different reasons, for example in case of rapid interest rates rise, so people start liquidating assets that don’t produce enough income. Or inflated prices for cars/homes start to collapse because sudden rise in interest rates makes people unable to afford arranging bank financing to purchase these durable goods. Another reason could be a Central Bank taking significant amounts of national currency from circulation by selling some assets or foreign currency on its balance sheet and not allowing money to flow or by raising reserve requirements for national banks so they create more reserves and reserved money is taken out from circulation. This also creates liquidity problem somewhere and currency becomes more valuable.

I’m not sure there is any other reason currency can go up. These reasons can exist simultaneously or can be compensated by reasons, why currency goes down in value:

  • Your economy gets less productive. Costs of doing business is getting higher and production output is contracting. This might be self-inflicted economic damage (like what happened right after USSR collapse when production fell more sharply than amount of money in circulation) or a foreign attack (if your industry is destroyed there are no goods to buy, but money is still in circulation).
  • You have a massive foreign currency outflow. Local currency is sold in exchange for foreign currency and this currency goes out while amount of local currency is not decreased.
  • Your economy experience a glut of currency in circulation and this currency chase goods that get much more in demand and therefore more liquid than normal. This can be a result of rapid interest rates decline or Central Bank assets buying spree (for example Chinese Central Bank tries to manage yuan value by buying large amounts of foreign currency inflow and therefore releasing too much of yuan into circulation)

As you see, there are only 3 primary factors: Production, Money Inflow/Outflow and Liquidity. Not sure there is any other primary reason for large-scale currency moves. If you identify one that is not a derivative from above, please let me know I would be happy to discuss.

So the value of currency is a good indicator of whether you economy is doing good or not. It is much harder to lie anout currency than about inflation (because of complex methodology government use to calculate Consumer Price Index).

You generally want capital to flow in, not out. You generally want economy to produce more, not less and you want liquidity to remain stable, because sudden change in liquidity is a sign of an economic imbalance correction or asset bubble collapse. You don’t want imbalances and bubbles to develop in a first place. So you want your currency to go up in value.

However, in a situation when budget largely gets revenue from selling natural resources on global markets and has expenses in local currency, government literally has opposite short-term interests to push local currency down. Central Bank collaborated and actioned this attack on our wallet. We have become poorer, not reacher because of this.

The recent decline in price of RUB. This was triggered by a combination of factors: low foreign currency inflow (resouce export is quite compensated by imports, and oil price is stagnant) and Central Bank policy change not to sell its foreign exchange reserves and not to take excessive ruble amounts out of circulation (supporting rubble liquidity after a number of banks failed in late 2013). This also ignited excessive FX speculation that exacerbated capital outflows and demand for foreign currency. Investors who watched this decided to run away and hide from FX risk, and companies decided to buy up dollars and euros to repay loans they have with foreign banks before this gets more expensive. I would rather say it is highly unlikely that this will have any positive impact on any industry in Russia except one: public sector is going to get rid of deficits for a while.

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