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Eureka: Currency exchange fluctuations explained simply and clearly Eureka: Currency exchange fluctuations explained simply and clearly
by Akli Hadid
2018-08-13 08:25:04
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There are basically four types of currency flows: individual and household flows, corporate flows, financial market flows and government flows. A fifth category could be International and non-governmental organization flows. For all five flows, you have inflows and outflows. Let me discuss the intricacies and some of the modern trends on currency flows and exchange rates.

-Individual and household inflows and outflows

exchang01_400There are two types of inflows and two types of outflows. Those who visit as tourists, leave the country as tourists, and those who send remittances to their families in one direction or the other. In the past, tourism flows were often from rich countries to less wealthy countries. Now that the recession has hit rich countries and that those from less wealthy countries have developed the travel bug, their governments are going crazy. For example, Thailand and Algeria have been begging their people to stay in the country for tourism rather than leave the country. But Algerians love France too much and Thais love China, Japan and Korea too much. So the dollar and euro have become a lot more expensive in those countries, mainly because fewer tourists are visiting, and more locals are doing tourism outside the country.

The same goes for remittances. In the past it was the Algerian immigrant in France who would send money to Algeria. Now Algerian immigrants in France are asking friends and family in Algeria to send them money to France because they're broke and have lots of debt piled up. So it's Algerians buying Euros in Algeria to send those Euros to France, which naturally makes the Euro more expensive.

-Corporate inflows and outflows

Many countries like Algeria have two, three, sometimes four currency exchange rates: one for individuals and households, one for corporations, in some cases one for the financial market and one for government transactions. In Algeria's case the household exchange rate is overinflated because there's a low supply and a high demand for individuals.

At the corporate level, again to take Algeria's example, when it used to be Italian, French, Turkish and Korean companies investing in Algeria, now it's Algerian companies investing in Italy, France, Turkey or Korea. Investments are either in direct form (Algerian companies opening businesses in Italy) or indirect forms (Algerian companies paying Korean companies for a service in Algeria). So naturally, when there is more outflow than inflow of foreign currency, foreign currency exchange rates go up. I say Algeria but you could replace that with any country you like.

-Government inflows and outflows

Governments often import goods and services and in some countries, like Algeria, state-owned companies export goods to foreign countries. For many years, in Algeria as in many countries, imports have outnumbered exports, which means you need to pay more dinars to get dollars. In countries like China, where exports far outnumber imports, you need very little renminbi to buy dollars, technically. However, the Chinese government confiscates a lot of the renminbi and keeps it in cash reserves, which basically makes the dollar even cheaper.

-Financial market inflows and outflows

Governments like to earn cash from passive income, either through bonds or through safe, in some cases not very safe financial placements. A lot of dictators put their money in those financial markets because financial markets are located in countries with strict inheritance laws and their kids will get the money back, not their cronies. In dictatorships a lot of the foreign currency flows out, meaning you need a lot of local currency to buy dollars. In democracies with solid financial markets cash flows both in and out of financial markets, making the foreign currency stable.

International organizations and foreign currency

In some rare countries, the only source of foreign currency is that of international organizations or international police or military forces. Some of that foreign currency comes in the form of financial aid, or in the forms of payments from police or military forces.

Debt and currency fluctuations

Some countries will have debts they will try to pay out by collecting foreign currency. That drives foreign currency prices up.

Pegging foreign currency

A dangerous practice done by some countries, mainly Asian countries, is to export a lot more than they import, foreign currency flows in a lot more than flows out, yet they will peg the foreign currency to their local currency and confiscate any foreign currency they can find, effectively banning or limiting people from spending foreign currency abroad, importing or placing foreign currency in foreign financial markets. This practice is dangerous because although foreign currency reserves pile up, what do you do with the foreign currency? If a dictator gets elected to power, does he take all the foreign currency and put it in his or her account? Plus foreign currency tends to lose value over the years through inflation, and many other reasons that's a bad idea.

Casinos and foreign currency

Yes, a lot of foreign currency is spent at casinos worldwide. A lot of it is also spent on luxury items and on failed investments. But that's another story. 



    
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