Have you ever wondered what causes the value of the dollar to fluctuate so much? Unfortunately, the answer is not that simple, as there are many factors at play. In this post we will talk about them and try to give you an overview of how each one of them acts in determining the value of the dollar.
First, changes in market inflation cause changes in exchange rates. So a country with a lower rate of inflation than another will tend to see an appreciation in the value of its currency, seeing the prices of its goods and services increase at a slower rate. In other words, a country with a consistently lower inflation rate exhibits an increasing monetary value, while a country with higher inflation generally sees depreciation in its currency. When comparing the United States and Brazil, we can see that the U.S. has historically had a much lower inflation rate than Brazil, contributing to its stronger currency.
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2. Interest Rates
Changes in the interest rate affect the value of the currency and the dollar exchange rate. Exchange rates, interest rates and inflation are correlated. Increases in interest rates cause a country's currency to appreciate because higher interest rates provide higher returns to lenders, thus attracting more foreign capital, which causes exchange rates to rise. Brazil over the years has had a higher interest rate than the US as a way to control higher inflation. This is a factor that brings strength to the Brazilian currency relative to the American currency. However, in an attempt to stimulate the economy, the Central Bank of Brazil has adopted a more expansionary monetary policy, lowering its interest rate accordingly.
3. Current Account of a Country / Balance of Payments
A country's current account reflects the balance of payments and earnings from foreign investments. It consists of the total number of transactions, including exports, imports, debt, etc. A current account deficit due to the country spending more of its currency on importing goods than it earns on selling exports causes depreciation of the national currency.
In the year 2019, Brazil ended the year with a current account deficit in the balance of payments of US$ 50.762 billion, being the largest annual hole since 2015. Upon seeing such news, an attentive person should already realize the negative impact this can bring to the real.
4. Government Debt
Government debt is public debt or national debt owned by the central government. A country with public debt is less likely to acquire foreign capital, leading to inflation. Foreign investors tend to sell their bonds on the open market if the market predicts public debt within a given country. And as a result, a decrease in the value of its exchange rate will occur. At the end of 2019, Brazil's public debt reached a total of R$ 4.248 trillion.
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5. Terms of Exchange
In relation to current accounts and the balance of payments, the terms of trade is the ratio between export prices and import prices. A country's terms of trade improve if export prices rise at a higher rate than import prices. This results in higher revenue, which causes a greater demand for the country's currency and an increase in the value of the currency.
6. Political Stability
The political stability and economic performance of a country can affect its monetary strength. A country with less risk of political turmoil is more attractive to investors from other countries, increasing foreign capital. This increase in foreign capital, in turn, leads to an appreciation in the value of its national currency. A country with sound financial and trade policy makes no room for uncertainty in the value of its currency, but a country prone to political turmoil may experience a depreciation in exchange rates.
Everyone who lives in Brazil is already kind of used to this kind of problem that has shown itself to be arising in our country. A clear example of this is well illustrated in the chart below, which is from May 2017, where it is easy to notice the jump that the dollar took on the 18th. This occurred when the newspaper "O Globo" published news that the owner of the company JBS recorded the former president of the republic, Michel Temer, giving his approval to buy silence of the former president of the Chamber, Eduardo Cunha. In other words, a clear example of political instability.
When a country experiences a recession, its interest rates are likely to fall, decreasing its chances of acquiring foreign capital. As a result, its currency weakens in comparison to that of other countries, thus lowering the exchange rate.
If the value of a country's currency is expected to increase, investors will demand more of that currency to make a profit in the near future. As a result, the value of the currency will increase due to increased demand. With this increase in the value of the currency, the exchange rate also increases.
All these factors determine the exchange rates, so if you are planning to send money abroad, for example, it is worth keeping up to date on these factors to evaluate when is the best time to make this transfer. But because there are so many factors that influence the exchange rate, I think it becomes clearer why it is so difficult to accurately predict the value of the dollar.
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