Traders are accustomed to the fact that the market is experiencing daily fluctuations in exchange rates, but what exactly does this mean for those who do not trade in the market? Exchange rates affect exports, imports, the economy as a whole and tourism. In this article we will discuss the essence of currency exchange and its implications for the economy and everyday life. Although in the past months the euro didn’t matter much (1 $ = 0.89 €), we will discuss what happens if 1 dollar costs 0.7 euro.
For simplicity, let’s take the relationship between the euro and the US dollar as an example. More precisely, we will discuss what happens to the economies of the United States and Europe, when the euro rises markedly against the dollar.
The impact of exchange rate changes in tourism.
If one dollar costs 0.7 euro, American citizens will probably be less willing to travel to Europe, since everything, from food to souvenirs, will be more expensive – about 43% more expensive than with parity between currencies. This illustrates the effect of purchasing power parity theory.
On the contrary, European tourists would be more inclined to visit the United States, both for business purposes and for leisure. American companies and municipalities (thanks to taxes) will flourish in those areas visited by European tourists, even if it is seasonal.
The impact of exchange rates on corporations and the stock market.
The impact of our scenario on corporations (especially large transnational corporations) will be more difficult, because these companies often conduct transactions in different currencies and, as a rule, receive raw materials from various sources. However, US-based companies that generate the bulk of their revenues in the United States (but receive raw materials from Europe) are likely to face lower profit margins due to higher costs.
Such problems would be faced by American companies that have to pay their employees in euros. Naturally, this reduction in the level of profits is likely to adversely affect overall corporate profits and, consequently, on the valuation of their shares in the domestic market. In other words, stock prices may decline due to lower earnings and negative projections regarding future potential.
On the other hand, American companies with an impressive presence abroad and a significant amount of revenue in euros (instead of dollars), but which pay their employees and incur other expenses in dollars, may be the winners.
European companies that receive the lion’s share of euro revenues, but also use components within their business or hire US employees, are likely to see an increase in profits as their costs decrease. Naturally, this can lead to higher corporate profits and an increase in share prices in some foreign stock markets. However, European companies that receive a significant portion of their revenues in the United States, but must pay in euros, are likely to suffer from rising costs.
The impact of exchange rates on foreign investment.
Europeans (both private individuals and corporations) would likely expand their investments in the United States in such circumstances. It is also better suited for acquiring business or real estate in the United States. For example, when the Japanese yen in the 1980s was trading at record highs against the dollar, Japanese firms actively bought American real estate, including the world-famous Rockefeller Center.
On the contrary, American corporations will be less inclined to acquire European companies or European real estate when converting a dollar at the rate of $ 1 = 0.70 €.
How to protect against currency fluctuations.
It is important to make currencies work for you. For example, when planning a trip, it is worth choosing the most timely currency conversion before booking a ticket. Also, tourists who make purchases abroad should use credit cards.
This is due to the fact that issuing companies usually agree on the best rates and the most profitable conversions, since they make a huge amount of transactions. These companies do all the work for you by simplifying (and possibly making cheaper) transactions.
One of the ways out for businessmen working in the United States and receiving raw materials from Europe is to increase supplies if the euro / dollar rate starts to rise.
On the contrary, if the euro starts to fall against the dollar, it may make sense to reduce stocks to a minimum in the hope that the euro will fall enough so that the company can save on the purchase of goods.
Futures and option contracts also exist for insurance against rate fluctuations.
Foreign exchange rates tend to fluctuate depending on various economic factors, which affects large and small investors. Individuals, investors and businessmen who take into account exchange rates can mitigate financial risks and take advantage of currency fluctuations to reduce the costs of a business or their transportation costs.
In trading, the influence of political and economic events on financial markets is considered as part of a fundamental analysis.