For as long as civilization is known to have existed, trade and treaties over goods have played a major role in economic empowerment. The most ancient settlements of the world were engaged in trade relations over each other’s natural and human resources, even though there was no ‘money’ involved. Fast forward to several centuries, and trade is still an essential aspect of measuring a country’s economic capacities.
The only difference is that today there is a systematic provision for measuring where a country stands in respect to its ‘purchasing power.’ The international trade arena has assumed an institutional significance. The strength of an economy in terms of its currency’s standing on the global level has come to determine its strength in the more dominating sphere of politics as well.
Economic Indicators
It is this ‘strength of the economy’ that has come to be interpreted in various forms and through different functions. The GDP and GNP of countries certainly help assess where they stand in terms of overall economic production. Different reports and evaluations of economic indicators such as interest and inflation rates, unemployment rampancy, and balance of trade also help determine the same.
The main purpose, therefore, of economic indicators is to study the business cycle and how it could potentially unfold in the future. The Currency Strength Index is also an economic indicator that permits the analysis and predictions of short- and long-term performance. It essentially ‘indicates’ how ‘strong’ or ‘weak’ a currency is, compared to its counterparts on the international level.
What is Currency Strength?
Currency Strength basically is the purchasing power of national currency either compared to other currencies or a standard one. The currency strength of a country lends significance to its standing in international trade over commodities and services. It is calculated in terms of the quantity of services and goods purchased for a single unit of national currency as well as the sum of foreign currency received in such an exchange.
The countries of the world are no longer perceived as isolated clouds of people engaging in barter exchanges and brutal wars alone. With the expansion of knowledge in geography and economy, countries now maintain stronger economic and political relations. The currency strength, or relative purchasing power, of countries determines their standing.
The Currency Strength Index – Basis and Dimensions
Just like any other index that expresses values and data associated with a certain factor of study, a currency strength index indicates the index value of currency for a country. It is, however, of significant importance in terms of the related data, it can be extrapolated into for purposes of inference and analysis.
The evaluation of this index is multi-dimensional and, therefore, quite dynamic. It is not just the relative purchasing power compared to foreign currencies, which is counted. Of equal importance is the utility of the currency and its relevance which is like an exchange device and financial valuation in foreign economies. Besides, the currency strength index is also based on the acceptability of the currency in international trade.
What does a higher Currency Strength Index mean?
A higher currency strength index, or higher purchasing power, means an increased ability to spend. Increased spending, in turn, translates into higher demands by consumers who can spend more. A chain reaction sets in motion and leads to an increased supply of goods in the market, increased imports and exports, and rich enhancement in terms of trade volume.
The most widely used currency strength index is the US Dollar Index. It acts as a reference for comparing and stating the index values of currencies of other countries. A study of this index lends an easy idea about the ‘strong’ and ‘weak’ currency indices and can guide judgments in the financial market.
Currency Strength is an Economic Indicator
It is important to understand that the currency strength index acts as a crucial measure of a country’s economy – both domestic and international. While it is easier to understand the role it plays in the international market, let us first try to understand its relevance in the domestic economy.
Currency Strength in the Domestic Economy
In the domestic economy, we can construe the same meaning for a currency strength index as we perceive in international domains. Here, the purchasing power is measured for the locally produced commodities and services. This is also where the central bank of a country comes to the fore – it is the currency strength index that it tends to preserve from time to time.
In dire situations, the purchasing power of the country, or its currency strength index falls. People have been spending less, there is lesser demand and hence reduced supplies. The central bank, in such a scenario, can take necessary actions.
Often, a boost in incomes and wages translates into greater spending. As mentioned earlier, a series of responses are triggered. Higher incomes lead to higher demands and spending, which leads to higher prices by corporates and hence higher profits. The impact can be felt in the overall growth of GDP.
However, the uncontrolled strengthening of currency can also lead to negative outcomes for the domestic economy in general. This is because it might lead to inflation in prices beyond what people can afford. Not all businesses will be able to pay their employees as much as they demand, and the outcome is sudden and mass layoffs.
There is no need to conjecture over the consequences of layoffs. The high inflation and overall rampant unemployment in the domestic economy can have dire consequences for public nutrition, health, education, and other necessities of living. Therefore, the currency strength index is a major determinant of the domestic economy of a country and needs continuous monitoring and dynamic policies.
Currency Strength in the International Economy
It is easier to comprehend the role of the currency strength index in the international economy. First and foremost, it is an indicator of the standing of a currency in the international market. This regulates the purchasing power of the country in terms of international trade, which is exports and imports.
A country with a higher currency strength index can easily go for purchasing larger quantities of goods and services compared to others for the same nominal value. Similarly, it will reap in greater benefits when exporting goods because of its higher currency strength index. The translation in terms of more value addition is advantageous.
However, a larger share of these factors is guided by the country’s policy in terms of its currency strength. For instance, a country might deliberately choose to maintain a lower value on its currency strength index. The obvious explanation is to attract foreign investors and buyers to buy commodities out of the country’s local economy.
This not just boosts international trade but also domestic production and hence the overall GDP. This is the primary reason Chinese smartphones are among the cheapest ones in the whole world.
Why is the Currency Strength important when trading?
The answer is simple – it helps you identify the stronger and weaker currencies to help devise your trading strategy accordingly. Firstly, the cardinal rule followed by those involved in trade activities is to learn to sail with the tide. You buy when the tide is low and sell when it is high, isn’t it?
The same strategy helps when dealing with currencies. The currency strength index is one of the main factors in determining the price rates of the Forex currency pairs in financial markets. Different events of national and international importance can lead to sudden disruptions in currency values. These guide the nature of the market and, in turn, influence the decisions taken by both short- and long-term investors.
Generally, the forecasts relating to a currency’s strength might come true. Depending on this fact, the currency might see either a strengthening or weakening on the global charts. However, it is no unknown fact that the financial market is replete with volatility and unexpected outcomes. This means trade and investment around currency strength is always a tight-spot situation.
Final words
The Currency Strength Index is one of the key determinants of not just international trade and standards but also the domestic economy. For someone who is trying to understand what Currency Strength is and how it is relevant in today’s world, suffice it to say that the index is a fundamental trend for traders, investors, governments, and the public alike.
The Currency Strength Index is also representative of the forex volume in general. A visual understanding of the strengths of different currencies in the form of graphs and charts comes in handy for this study. While there are many platforms and applications to keep track of the Currency Strength Index and analyze its trends over time, it is equally important to understand its relevance in today’s competitive global village.