Source: Mr Cox using Smartboard technology
Source: Mr Cox using Smartboard technology
If you want an alternative explanation, try this video....
Source: Youtube.com
The Determination of Exchange rates
Millions of pounds worth of currency are traded every day. Anyone can buy or sell currency 24 hours a day. In order to buy goods from other countries people need to first buy that country’s currency. It is that demand for the currency (and supply) that affects the price.
Currency can be demanded for a number of reasons:
In order to supply our currency, we make it available to other countries in exchange for their currency (in other words, undertake the above activities in other countries)
The price of the currency is always determined where supply and demand of the currencies cross.
Fundamentals that drive a currency
Interest rates
Economic Growth
Countries experiencing a deep recession often find that their exchange rate is weakening. Traders in the currency markets may take the slow growth to be a sign of general economic weakness and "mark down" the value of the currency as a result. On the other hand, economies with strong "export-led" growth may see their currency's rise in value. Japan is a good example of this in recent years. The Euro was weak during the first six months of its existence in part because the financial markets were worried about the slow growth of the European economy and the persistently high level of unemployment.
Inflation
Balance of Payments/Trade
Selling exports represents a demand for the domestic currency from foreign importers. When US consumers buy British Whisky they supply dollars and this is eventually translated into a demand for pounds. Similarly when UK consumers buy imports, they supply their own currency and this is eventually translated into a demand for foreign currencies. If a country is running a substantial trade surplus there is a large demand for the currency and its value should appreciate. By contrast a massive trade deficit usually causes the currency to lose value.
Market Speculators
It is difficult for governments to offset the power of speculators because their reserves of foreign currencies are very small compared to daily turnover in the market. We saw in 1997 and 1998 speculative attacks on currencies in Asia and in 1993 the pound was forced out of the European exchange rate mechanism because of speculative selling of the pound.
Measuring the Exchange rate
Source: Mr Cox
