How to Analyze Foreign Currency Investments

Complexities of Analyzing Foreign Currency Investments

Trading currencies can be very profitable, but it is also high-risk. Relative currency values require a ton of analysis, and include many unpredictable factors. When you trade currencies between two countries, let's say using U.S. Dollars (USD) to buy Venezuelan Bolívar (VEF), you are making a bet not just on Venezuela, but also on the U.S. Venezuela's economy could improve by 10%, but if the U.S. has that same improvement, the relative currency values will remain stable. 

Researching Currencies

Currency trading requires an investors to research not only the country they are investing in, but also their home country to determine which direction they expect both countries' currency to go. Investors should investigate multiple factors that influence each country's economy. Investors should then compare and contrast the factors within one country against those same factors in the other country. The factors that should be considered include Economic Conditions, Governmental Decisions, Technology, and Sociocultural Change.

Relative Economic Conditions

Economic conditions within each country will have a dramatic impact on their respective currencies.  As a result, you will need to track the historical and current economic trends for each country including employment rates, industry growth, GDP, efficiency and productivity statistics, inflation, international investments and divestitures, and other measures of economic activity.

As each of these key economic measures improves within a country, the country's economy will strengthen. This will then strengthen their currency. Of course, that strengthening may be offset by the weakening of other economic measures. Looking at any one of these indicators alone could provide you with an incomplete view of the country's economy.  

Government Stability/Decisions

Depending on the countries you are comparing, the government could account for anywhere from 20% to 100% of the total spending/economy of the country. As a result, government decisions will have significant and long-ranging impact on the value of their currency. 

Greece, for example, provided massive social programs to their people though government-sponsored retirement, vacations, medical care, and other services. This ended with a collapse of the Greek economy, which would have made their currency worthless if they had their own currency instead of using the Euro. The decisions made by Greece and a few other countries, though, did have a dramatic effect on the value of the Euro in the world economy.

Chile, on the other hand, made a decision to offer free money to tech entrepreneurs if they came to Chile. The execution of the plan was flawed, but that investment could have significantly improved the country's economy. This, though, shows another potential difficulty with government decisions, which is that even if their ideas are innovative and beneficial, the execution of the ideas through the governmental process could still cause the economy to falter.

Magnifying all of this, is the stability of the country and its government. The U.S. has a relatively stable government, with very little real difference between the two parties. Many European countries, however, have dozens of parties all vying for control. As a result, coalitions are built by bringing multiple parties together for short-lived timeframes. This type of system creates an environment where government decision could be dramatically different from year to year. Then there are those countries that change their entire government (sometimes violently) as often as the U.S. changes Presidents. When these brand new governments come in, they can issue brand new currency, making any investments in the old currency worthless.

Government Interventions

A sub-category of Government Decisions is Government Interventions. Governments actually intervene in economic systems with the intention to control the value of the currency. Most governments do this through the amount of currency they print, interest rates, issuing and buying bonds, and other monetary and fiscal policies. As a result, a change in the government strategy could impact the currency.  

Monetary intervention is a specific government intervention where a government purchases or sells large amounts of a foreign currency in the foreign exchange markets in order to artificially increase or decrease the value of its own currency. China has been accused of doing this to a degree that it amounts to currency manipulation; completely fabricating the value of the Chinese currency relative to other currencies like the U.S. dollar.

Technological Advancements 

The impact of advances in technology is often underestimated, especially in how it relates to currency markets. Technology advances  can become wildly profitable for companies that develop them, but that also improves the home country's economy and their currency. Countries that are likely to experience technological advances and developments within their economy will also likely experience a strengthening of their economy, especially if those technologies are sold overseas.

Aside from technological advances developed within the country, a society's adoption of technology in general will also have a great impact on their economy. The light bulb, telephone, airplane, and personal computer were all invented in the United States; but each of these inventions have had profound and dramatic effects on every country in the world. As countries adopted these inventions, they experienced dramatic improvements in productivity, economic activity, and quality of life. The same is true for new technologies being developed today. The more a country modernizes with emerging technology, the more robust and product its economy will be.

Technology also can have dramatic impacts on a country's economy regardless of if the technology ever makes it within the national borders. Further development of solar panel technology will have a dramatic impact on many Middle-Eastern economies, simply because solar energy will greatly change the demand for fossil fuels. Even if not a single solar panel makes its way to Saudi Arabia, the economy and currency of Saudi Arabia will be forever changed as solar energy technology advances.

Sociocultural Change

The final factor that should be researched is how the society and culture within a country is changing. Societies that remain centrally controlled by a ruling few usually have large swaths of poverty throughout the country. As these societies transition to more democratic and capitalist systems, economic development often increases. This can present significant opportunities for growth within the economy.

Education of the population also becomes a key factor for economies. Societies that have a more educated workforce are far more competitive in the global marketplace. As developing countries expand educational opportunities and increase the average level of education within their population, their economies will see significant benefit. This benefit will materialize not only because the society is more productive, but also because foreign countries will be more willing to do business with and within the country.

Demographic shifts should also be considered, as they can  have dramatic impacts on a countries economy. An aging population may signal future economic difficulties as the society struggles with a shrinking population of working age combined with a growing retirement population that must be supported.

How to Invest in Foreign Currency

If you are interested in investing in foreign currencies, there are a number of options for how to invest. You can learn more by reading 6 Ways to Invest in Foreign Currency.

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