Consequences of the recent exchange rate changes
As a follow up to the previous article regarding exchange rate turmoil, our Economics author George Graves identifies some of the major consequences of exchange rate volatility.
Perceptions and confidence
Despite the fact that sometimes a depreciation of a currency might be beneficial and an appreciation might be problematic, the popular perception is that the former is bad and the latter is good. These perceptions are reinforced by the language used to describe exchange rate changes in the media. A currency that depreciates is described as weak and plunges while one that appreciates is strong and soars. This terminology is typically used to describe the Turkish lira, the recent fall in the pound, and the corresponding rise of the dollar. These perceptions, however accurate, are important because they affect consumer and business confidence as well as trader confidence in financial markets. Currently, confidence in the UK and Turkish economy is low while the opposite applies to the US economy.
Reality check
Loss of confidence in a country’s economy and currency can have a negative impact on growth as domestic and foreign firms are reluctant to invest and the currency depreciation will add to cost-push inflationary pressure as prices of imported energy and food will increase. Interestingly the UK inflation rate has increased to 10.1% (19/10/2022) which is at least partly fuelled by the depreciation of the pound.
The loss in value of the Turkish lira is also a major cause of Turkey’s high inflation rate. However, against this is the boost that the lower exchange rate gives to the country’s exports. Turkey has managed to attract record levels of tourists this holiday period and has also managed to increase its exports of goods such as textiles on the back of the cheap currency. The strong dollar will have the opposite effect on the US economy with some loss of competitiveness for exports but lower import prices that will help to fight inflation. Some students might decide that it is more economical to study in the UK rather than the USA.
The global importance of a ‘strong’ dollar
Apart from the impact of exchange rate changes on domestic economies there is also a significant effect of the dollar value on the global economy. As the worlds universal currency, the dollar’s value influences the prices of a wide range of commodities that are traded on world markets such as energy, metals, and a host of agricultural commodities. This means that the cost of importing these commodities in domestic currency rises in line with any dollar appreciation in addition to any commodity price increases that occur. For economically less developed countries this presents a particular hardship and especially for countries that have to service their debts in dollars.
Unfortunately, the Fed does not appear to be concerned with the impact that an appreciation of the dollar has on other countries’ economies and pursues an interest rate policy geared exclusively to what is deemed to be necessary for the domestic US economy. In response to the Fed’s increases in US interest rates, other countries are obliged to increase their interest rates in order to support their currencies and this increases the risk of their economies falling into recession.
