Whilst economic data tends to dominate the forex markets, with the market price action punctuated with volatile swings as this data is released on a twenty four hour basis, this is far from the end of the story.
Currencies and currency rates move for a variety of other reasons, and the purpose of this section is to explain these, and how and when they may arise, so that you have a complete picture.
And indeed, it is the complete picture which is explained in my book A Three Dimensional Approach To Forex Trading. To succeed as a forex trader requires just that – a three dimensional approach which incorporates the three elements of relational analysis, technical analysis and fundamental analysis.
The currency wars
Over the last few years the term ‘currency wars’ has entered the standard forex market vocabulary as it is both a descriptive and precise phrase which sums up the problems that many governments around the world have faced in the last few years. At the heart of the problem lie exports, the life blood of a strong export driven economy such as Japan, the US and of course Germany, which ultimately led to the currency wars, which still rumble on today. So why did the currency wars ever start – the answer is very simple and was the consequence of several factors.
When a country exports it’s goods or services, buyers overseas generally pay for these goods and services in the currency of the home country. So a buyer in the USA buying Japanese goods will pay for these goods using the dollar to yen exchange rate. Suppose the rate was 80 yen to the dollar, then an item costing 800 yen would cost the US buyer 10 dollars. Now imagine the yen to dollar exchange rate has moved to 70 yen to the dollar, the same item now costs the US buyer 80/70 x 10 = $11.42 or an extra $1.42 – not much you might think, but in percentage terms this is a %14 increase in price to the buyer for the same item. Now imagine this is a major car importer buying from a major Japanese exporter such as Honda or Nissan, the problem becomes massive for the exporting country.
In the above example, the exchange rate for the USD/JPY moved from 80 to 70, so in other words the Japanese yen was becoming stronger against the US dollar, and herein lies the problem for governments and central banks around the world. If a currency is allowed to strengthen unchecked, then ultimately exports may collapse leading to an economic slump and possible recession as demand for the goods and services falls and eventually stops as overseas buyers look elsewhere for cheaper alternatives.
Whilst this is a problem in itself, it has been exacerbated in the last few years, with the world wide slump in demand for goods as virtually every country entered a period of economic stagnation, followed by a decline and long slide into recession. As a result, central banks and governments came under increasing pressure both politically and financially to prevent their currencies strengthening in order to protect their fragile markets, whilst at the same time accusing other countries of weakening their own currencies using unfair policies in order to protect their own export markets.
All of this ultimately led to the currency wars as countries around the world battled to devalue their currencies in order to protect jobs, their export markets, and ultimately their people. This in turn led to frequent currency intervention from the central banks, which is one of the factors one needs to be aware of, particularly from certain countries, and is often the reason we see sudden sharp spikes in a currency as the central bank intervenes to try to prevent further strength developing against other major currencies.
Currency intervention from central banks is just one of the other influencing factors, but there are others. Not least are statements from senior politicians wishing to help their currency, financial leaders and government officials, and finally of course the G7 or G20 group whenever they meet.
Sadly, natural disasters also play their part, and the recent Japanese earthquake and consequence currency flows had a major impact on the short term exchange rates.