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What COVID-19 teaches us about foreign currency fluctuations What COVID-19 teaches us about foreign currency fluctuations
by Joseph Gatt
2020-08-24 10:14:41
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I have 100 bucks. I could use 100 bucks for “needs” purposes (to buy stuff). I could hoard 100 bucks and hoard dollars for different reasons (a safety net, savings, or to blackmail people who some day might desperately need foreign currency). Or I could trade foreign currency professionally, that is currency swaps will be my job, and I will keep whatever profits I make from the currency swaps for daily living activities.

How do you determine the exchange rate?

-You can use the calendar. In some countries, foreign currency is in demand at some times, and in supply at other times. For example, in Turkey, Tunisia, Morocco, you get a lot of Euros coming in during the summer, as a lot of European tourists trade their Euros for Liras, Dinars or Dirham’s.

coromon001_400Then, around late August-Early September, it's Euros that are in demand in Turkey or Tunisia. That is you will have tourists trying to trade whatever excess Dinar or Lira they might have for Euros. And then you have Turkish and Tunisian students and immigrants who will trade their Lira or Dinar for Euros so they can study or live in Europe.

So, in Tunisia during the month of July, you will overvalue to Dinar so you can get more Euros. So instead of 1 Euro buying you 3 dinars as in October or November, in July, 1 Euro will usually get you 2 Dinars or 1.5 Dinars.

-But the calendar is not the only means to adjust currency fluctuations. You also want to look at your country's clients, and how likely they are to purchase products from your country. Currency is not just about tourists, it's also about businessmen.

So you want to look at client countries. Turkey will look at the European Union, Mexico will look at the United States.

So if EU stock market and commerce indicators are strong, Turkey will give more Liras for its dollars. Same goes for Mexico, if the US business sector is strong, that means Americans are more likely to purchase Mexican goods, so the Mexican Peso could use a little bit of undervaluation and you get more Pesos for each dollar for bringing in dollars.

-Financial market behavior. Now remember foreign currency is not just about paying for hotel rooms and a boat trip or 20 containers full of corn or textiles.

Foreign currency is also about hoarding, and is also a job for those who buy and sell foreign currency.

So hoarders are going to try to get rid of their foreign currency when they feel like the value is going to go down, and go down for good.

So if China is hoarding US Dollars, the Chinese financial market could try hard to sell its Dollars and try to purchase other currencies (Hong Kong Dollars or Euros or what not) and could sell its Dollars at a discount price. That will cause the Dollar value to go down.

But in times of global slowdown (like right now) China might offer its dollars at a symbolic price to get the kind of currency it needs to survive, as China desperately needs to bail out its economy.

So China could try to get rid of its dollars by trading it for hoarding other non-perishable goods (rice, canned foods, real estate) or try to trade its dollars for Gold with the dollar severely undervalued (and gold severely overvalued).

-What about people whose job is to trade currency? They turn out being the backbone of the currency exchange business. They are the ones who are going to figure out how to make a living.

So currency exchange professionals in Turkey in COVID-19 times for example could give up their dollars or Euros at a symbolic price, hoping someone in Turkey is optimistic about the dollar or Euro and is willing to bet on the dollar or Euro by purchasing such currency at a symbolic price. And the currency exchange professional will get any Turkish Lira he or she can to buy groceries for the day.

But then, when America and Europe announce that they are going to reopen the economy, that's when the currency exchange professionals are going to bring back the Dollar and Euro to a strong level, and the Turkish guy is going to ask for more Liras in exchange for his Dollars.

-Government intervention and currency exchange

Some governments and national banks like to “court” European or North American or Asian investors and traders by undervaluing their currency. That is the Tunisian government could say “we'll give you 10 dinars for a Euro instead of 3 Dinars for a Euro, but please come invest, shop, or visit Tunisia.”

Some governments on the contrary could overvalue their currency (like North Korea) to prevent foreigners from doing business or visiting. That is in North Korea 1 Dollar gets you 2 Won (until recently) and you can't do a whole lot with 2 won (it will get you a small bag of cookies or a pack of gum). The North Korean government was trying to get as many dollars as it could, making life for foreigners artificially expensive.

What about China? China is notorious for undervaluing its currency, and you can get lots of Renminbi for few dollars.

Why is that a problem? Because a lot of Americans and Europeans are going to open shop in China.

You see for the Chinese who don't own Dollars, life in China can be expensive. But if you work or do business for 20 years in the US, and can move your business to China where your operation costs are going to cost you 10% of what it would cost you to operate your business in the US, yet you get the better profit margins because you are going to sell your smartphone or toy or printer at American prices.

But why would that be a problem? Because it makes life hard for the Chinese people. If I'm Chinese and that I have to give 100 renminbi to get a dollar when I should really be giving 30 renminbi to get a dollar, that means, as a Chinese, I can't do business in the US, I can't study in the US, I can't visit the US, I'm stuck in China basically.

And even when in China, life is artificially expensive for the Chinese who get paid renminbi wages. Not to mention that the Chinese could never purchase imported goods, that the Chinese have trouble purchasing housing, cars, and any other product. And that makes American products expensive in China. Then you have the Chinese youth stuck with no other choice than to play video games all day, because there is little else that they could purchase.

Finally, what about those who “peg” their currencies to foreign currencies.

The South Korean Won for example is de facto pegged to the US Dollar, and it's usually 1,000 Won for a dollar (oscillates between 900 Won and 1,300 Won).

Why would the South Koreans peg their Won to the US Dollar?

This practice is not fair for Samsung or LG who would want more flexibility, by undervaluing the Won so they can get more Korean Won for their hard-earned dollars (let's say 2,000 Won for the Dollar).

But the South Korean government does worry that Samsung, LG or Hyundai or KIA get greedy (those companies make most of their income in dollars) will lead to an eternal undervaluation of the Korean Won (Samsung is going to demand that the Won get valued at 2,000, then 3,000, then 5,000) and that's going to make life impossible for ordinary South Korean citizens.

So the South Korean government says: eins für eins, 1 dollar will always be around 1,000 won.

What about Latin Americans. It's this very practice of Ecuadorians making a ton of dollars selling bananas to the US and then those banana exporters forcing the government to devaluate the Ecuadorian Peso so they can have more Pesos that wrecks the Ecuadorian economy.

But on the other hand, the South Korean won is a bit overvalued and should really be at around 2,000 Won to the dollar in real PPP terms, because, let's be honest, almost every South Korean product costs double what it should.

In sum, COVID-19 has taught us stuff about currency exchange we wouldn't have noticed.


    
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