eli5: The value of a currency and trade blance

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The value of currency is determined through the laws of supply and demand. What I don’t understand is why can’t a country with high imports rate preserve the value of its currency if it also has a high export rate and there’s a lot of demand on its currency as well?

In: Economics

4 Answers

Anonymous 0 Comments

They can, sorta, but it is not necessary. If people want to invest in your country, you can run a trade deficit and still have a strong currency. So you may be better off having an economy worth investing in (property rights, courts, educated people) And of course, if your currency weakens, your exports should get cheaper and you’d export more, but of course you need to have industries that can export in the first place.

Anonymous 0 Comments

A country can’t control its export rate. That depends on who wants to buy the stuff they sell. They can tamper with the market, by lowering prices for example, but that’s pretty easily detected and leads to trade sanctions.

Anonymous 0 Comments

Import and exports are traded goods. So a country with reasonably balanced and large international trade volumes (plus stable governance) can maintain a rather stable currency. The demand and supply of foreign reserves will be somewhat balanced for that country.

Of course the goods exported must actually be produced and sold – ie there must be actual realized demand for the exports. Theoretical or potential exports are of little use.

Anonymous 0 Comments

The value of a currency depends on how many people need to buy it using a central currency.

You have some people who are spending your local currency to buy a foreign currency, and some people who are spending a foreign currency to buy your local currency.

For example, a Canadian business might be selling their product to the US in USD, and so they need to buy Canadian dollars with their USD in order to pay their employees. But then Canadians may take their Canadian dollars and buy US Dollars to buy goods and services from the US.

If the exchange rate is too high (like $1CAD to $1USD), then the companies might be struggling, because their employees salaries haven’t changed but effectively cost more USD to pay. Similarly, if the exchange rate is too low (like $0.50CAD to $1USD), then there won’t be as many Canadians buying USD to go shopping because things end up costing extra.

All of the currency exchanges happening back and forth create a sort of equilibrium point for most stable currencies. If it gets too expensive in either direction, then those transactions will naturally slow down, allowing the value to slide back in the other direction.

Big shocks like Brexit or trade war tariffs can create permanent changes because it completely changes the nature of those balancing transactions for reasons besides the actual price.