Most individuals are indifferent to changes in valuations of currencies; and it is only when they go on holidays abroad that the exchange rate becomes topical.

In the business world it is much more relevant, however. Pretty much every business will use tools or products that have come from another jurisdiction, which probably uses another currency.

What drives the value of a currency in relation to another?

First of all, it is always a relationship; i.e. it is not the value of the USD in absolute terms; it is that value against the EURO for instance; or against GBP (The Pound Sterling).One way to look at this is called PPP “Purchasing Power Parity”. The most famous example is the price of a McDonalds hamburger across the world. Since McDonalds are present everywhere, have very efficient production lines and a cooking process that is the same in every restaurant, down to the number of employees in the kitchen; then the price should be close to identical. And it is not in reality. PPP is the theoretical version of the McDonalds test.

In theory a currency should be sought after, if its economy is doing well, and its interest rates are low. Low interest rates help economic creation, whereas high interest rates hinder it. Quite often high interest rates are needed to fight inflation; to make the cost of money higher which in turn will slow inflation down. If inflation is at 10 percent, one will need 110 units to buy the same thing that costs 100 today; hence the need to fight this. However, in practice there are cases when the currency appreciates when the central bank raises interest rates. This is because institutional investors are likely to invest funds where savings rates on offer are higher; or that the central bank is raising them to fight inflation to make the economy on a stronger footing.

What is happening now?

The US Dollar has gained more or less 15% across the board, and the Dollar Index “DXY” has reached all times high (it is a basket of currencies revalued in USD). It means that all other currencies have depreciated a very great deal precisely at the time that commodities have gone up because of the war and logistics issues due to covid. An example: the EURO against the USD has gone from 1.15 to 1.05; while the price of oil has gone from USD 70 to USD 110 per barrel.

Any European importer has to change their euros into dollars to buy these barrels; so to them the price has gone from 70/1.15 to 110/1.05 i.e. 61 to 105 euros making the cost even more expensive (in dollar the price of the barrel has changed by 57%; in euros by 72%).

The problem is that all commodities are priced in US dollars. Be they metals (iron, nickel, copper…); energy (oil, gas); food (grains, coffee, sugar…). Unless a country is a producer of these, importing has become much more expensive; in other words it is driving inflation.

In addition, emerging countries (most of Africa and Asia) have debts denominated in US Dollar because they need access to it in order to fund capital investments and purchases of commodities. To these countries a high USD is a major issue. We just saw Sri Lanka default on its foreign debts because of this and the country falling into riots over the price of food and energy.

The US government is of course aware of these unwanted consequences, but their priority is to put the US economy back on track too; a conundrum. In order for the Dollar to lose its appeal other governments will have to raise interest rates to make their currencies more attractive; a tough choice since their economies are already suffering from high inflation.

The blue sky scenario would of course be some conclusion to the Ukraine war which would burst the balloon of high commodity prices.

Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. Although endeavours have been made to provide accurate and timely information, we cannot guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough review of their particular situation. We cannot accept responsibility for any loss as a result of acts or omissions.


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