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How the Economy Affects Money Transfers

For as long as money has been in existence, economic events have had an effect on currency. History is littered with economic disasters, World War I rendered Germany financially crippled; not only did the great depression determine the economic direction of the 1930’s, it shaped the future of the United States and its immigration policies. The price of oil has caused chaos and war in the Middle East and other parts of the world. Every crisis and political and economic event have affected currency and therefore the exchange rate.

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How the Economy Affects Money Transfers

All money transfers are based on the exchange rate, if the economy is unstable, it is more than likely that countries will have a weak currency. Exchange rates are dependent upon the value of a currency, and when the value of a currency is low, the exchange rate is also low. There are several factors that impact currencies such as inflation, interest rates, national debt etc. Therefore, it is important that when people transfer money from one country to another, they understand what is taking place in the economy of both countries.

Key Economic Events That Have Affected Money Transfers

The European Debt Crisis: In 2008, the Eurozone had its biggest crisis; countries had to borrow money to get out of debt which led to a severe recession and the collapse of the economy. As a result, several regulations were introduced which transformed the landscape of the Eurozone’s financial system. The Euro as well as other currencies in Europe started fluctuating and the value of the Euro is still suffering the consequences. 

Brexit Decision: In 2016, fifty one percent of the British public voted to leave the European Union. The referendum held on 23 June was named Brexit and this decision had a negative effect on the British pound. It immediately fell from 1.34 against the Dollar to 1.24 against the Euro, and so far, has dropped to as low as 1.13 against the Euro. Many other currencies were affected by Brexit including the Canadian dollar, the Australian Dollar, and the US dollar. 

The Nixon Shock: The Bretton Woods system was designed to stabilise economies after the two world wars. However, this changed in 1971 after the agreement was unilaterally terminated by president Nixon. The United States dollar became a free-floating currency, and a short while later, the pound experienced the same fate. As a result, there was a dramatic negative impact on all major currencies. 

Oil Crisis in 1973: In response to the United States involvement in the Yom Kippur war, an embargo was placed on the oil trade by Middle Eastern states. This led to a global economic crisis because countries were unable to trade oil. The pound almost collapsed because inflation had increased and financial experts thought that the pound had been overvalued, it only recovered because the government was forced to intervene.

The Earthquake in Japan: Natural disasters also have an effect on currency values. The earthquake in Japan was the worst to hit the country in over a hundred years. While the initial damage to the economy was severe and the value of the Yen dropped significantly, it eventually experienced a massive boost with overseas insurance and repatriation. Today the Yen is one of the most powerful currencies in the world. 

The Gulf War: The Gulf war had a major effect on Iraq’s economy. The United Nations enforced sanctions on the country which destabilized Iraq’s financial system. As a result, there were several direct and indirect consequences and one of them was that Iraq was no longer able to print currency using the Swiss printing method. Therefore, they were forced to adopt a new dinar that was of inferior quality. The inferior value of the new dinar led to overprinting and combined with the sanctions the value of the new notes declined sharply. 

Financial Crisis in Russia: The Russian economic crisis is an ongoing one, due to economic sanctions and plummeting oil prices the ruble collapsed. What took place in Russia is another example of how external factors such as politics and commodities can lead to major economic catastrophes. 

Managing Risk From Economic Events

The purpose of visiting history is to ensure that we don’t make the same mistakes. In terms of the economy, we must pay attention to what financial experts are predicting about future events. For example, oil is still a major factor affecting economies in the Middle East and other parts of the world. One thing we do know is that the price of oil will always fluctuate. 

One of the most effective ways of managing risk against economic events is to set up a forward contract. A forward contract involves locking in an exchange rate at its current price so that the rate is not affected by future fluctuations. It is important to mention that this is not something everyone can do because the contract only allows for a minimum of £30,000. You will pay a 10% deposit of the total amount you plan on exchanging and the rate is fixed for up to two years.

Using a forward contract to lock in your exchange rate is ideal for people who are planning on spending large amounts of foreign currency in the future. For example, if you intend on retiring to Italy in two years but you are concerned that the sterling might decline against the Euro before you relocate, you can fix the exchange rate. 

By fixing your exchange rate, you will know exactly how much foreign currency you will receive in advance. A fixed contract also gives you a sense of security knowing that you are protected against any fluctuations. 

The only disadvantage to a fixed contract is that once the rate is fixed, if the exchange rate goes up, you will not benefit from the increase. Therefore, it is important to pay attention to exchange rates and lock your rate in when your currency is at its strongest.

Summary

Economic unrest, political turmoil and war are just some of the events that can have a catastrophic effect on the currency markets. Much of a currency’s value is determined by the economic stability of the nation and any unpredicted economic instability will have a detrimental effect on the currency. Although it is almost impossible to prepare for the unexpected when it comes to the forex market, as mentioned, one of the most secure ways to protect against currency fluctuations is to lock in your exchange rate with a fixed contract.