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Chapter 3.1
Capital and Trade Flow Drive Currency Values
                                0
In this section, you will learn how the following affect the supply of and
CAPITAL AND TRADE FLOW DRIVE                                              demand for a currency:
CURRENCY VALUES
Supply and demand are the simple concepts behind all price movement




                                                                          Contents
in the forex market, and no two fundamental economic indicators are                  Capital Flow
better suited to measuring supply and demand than are capital and
trade flow.                                                                          Trade Flow

Capital flow measures the money that is flowing in and out of an
economy for investment purposes—like buying stocks and bonds or
merging with or acquiring another company.

Trade flow measures that money that is flowing in and out of an
economy for the purchase of tangible goods and services—like cars,
electronics and professional services.

As money, whether it is for investments or for goods and services,
flows in and out of an economy, the supply of and demand for that
economy’s currency rises and falls. This causes the value of that
currency to rise and fall as well.




                                                                      1
CAPITAL FLOW
Money crosses borders every day in ever-increasing amounts.
Globalization has made it easier and easier for investors to put their
money to work in virtually any economy around the globe, regardless
of where they live. Investing in stocks on the New York Stock Exchange
(NYSE) or the NASDAQ is just as easy as investing in stocks on the
London Stock Exchange (LSE), the Frankfurt Stock Exchange or the
Tokyo Stock Exchange.

Global investors have an impact on the levels of supply and demand for
currencies around the world. Let’s take a look at how the actions of
these investors influences the value of a currency.

Here you can see a typical supply and demand chart. Demand is
represented by the line that is sloping downward from left to right, and
supply is represented by the line that is sloping upward from right to
left. The point at which these two lines cross represents the price the
market will accept for the currency.




                                                                           2
The flow of capital from one economy to another affects the currencies
of the two economies involved in the exchange. Take a look at how the
following can impact the value of a currency:



 -    Increasing demand

 -    Increasing supply

 -    Decreasing demand

 -    Decreasing supply




                                                                         3
How Increasing Demand Affects Currency Values

Increasing demand for a currency increases the value of that currency.

Looking at the supply and demand chart below, you can see that as
demand increases, the demand curve moves farther and farther to the
right on the chart. As it moves farther and farther right, the point at
which the demand curve crosses the supply curve also moves higher
and higher. This tells you that increasing demand for a currency
increases the value of that currency.




                                                                          4
Demand for a currency increases as investors move their money from
another economy into the economy represented by that currency. For
example, when investors in Japan want to buy U.S. government bonds,
they must exchange their Japanese yen (JPY) for U.S. dollars (USD). This
increases the demand for—and thus the value of—U.S. dollars (USD).




How Increasing Supply Affects Currency Values

Increasing supply of a currency decreases the value of that currency.

Looking at the supply and demand chart below, you can see that as
supply increases, the supply curve moves farther and farther to the
right on the chart. As it moves farther and farther right, the point at
which the demand curve crosses the supply curve also moves lower and
lower. This tells you that increasing supply of a currency decreases the
value of that currency.




                                                                           5
Supply of a currency increases as investors move their money from the
economy represented by that currency into another economy. For
example, when investors in Japan want to buy U.S. government bonds,
they must exchange their Japanese yen (JPY) for U.S. dollars (USD). This
increases the supply of Japanese yen (JPY), which decreases their value.




How Decreasing Demand Affects Currency Values

Decreasing demand for a currency decreases the value of that currency.

Looking at the supply and demand chart below, you can see that as
demand decreases, the demand curve moves farther and farther to the
left on the chart. As it moves farther and farther left, the point at which
the demand curve crosses the supply curve also moves lower and
lower. This tells you that decreasing demand for a currency decreases
the value of that currency.




                                                                              6
Demand for a currency decreases as investors stop moving their money
from other economies into the economy represented by that currency.
For example, when the Bank of England (BOE) lowers interest rates,
U.K. government bonds become less appealing to foreign investors
because they offer a lower rate of return. If foreign investors do not
want to buy U.K. government bonds, they do not need to exchange
their currency for British pounds (GBP). This decreases the demand
for—and thus the value of—British pounds (GBP).




How Decreasing Supply Affects Currency Values

Decreasing supply of a currency increases the value of that currency.

Looking at the supply and demand chart below, you can see that as
supply decreases, the supply curve moves farther and farther to the left
on the chart. As it moves farther and farther left, the point at which the
demand curve crosses the supply curve also moves higher and higher.
This tells you that decreasing supply of a currency increases the value of
that currency.




                                                                             7
Supply for a currency decreases as central banks increase reserve               two economies involved—and supply and demand drive currency
requirements to pull money out of circulation. For example, when the            prices.
U.S. Federal Reserve increases reserve requirements for its member
banks, it tells them that they must keep more of their money in reserve         Here you can see a typical supply and demand chart. Demand is
instead of lending it to borrowers. This makes it more difficult for            represented by the line that is sloping downward from left to right, and
corporations and individuals to borrow money, which effectively                 supply is represented by the line that is sloping upward from right to
reduces the amount of money that is in circulation.                             left. The point at which these two lines cross represents the price the
                                                                                market will accept for the currency.



Trade Flow
Chances are if you look at the electronics, toys and clothing you
bought during this past year, you will find they were made somewhere
outside of the country you live in. Global trade has blossomed, and it is
now possible for virtually anyone to eat bananas from South America
on dishes from Europe while watching a television made in China.

Trade flow between economies affects currency values. Every time
goods or services exchange hands, money also has to exchange hands.
European importers have to exchange money to buy goods from
Japanese exporters just as Japanese importers have to exchange money
to buy goods from European exporters. Each time importers exchange
money, it affects the supply of and demand for the currencies of the




                                                                            8
Take a look at how the following can impact the value of a currency:



     -    Increasing demand for the exporter’s currency

     -    Increasing supply of the importer’s currency



    Plus, you can monitor what affects trade flow may be having on the
    currencies you are trading by watching perhaps the most important
    trade-based fundamental economic indicator: trade balance.




9
How Increasing Demand from Importers Affects
Currency Values

Increasing demand for a currency increases the value of that currency.

Looking at the supply and demand chart below, you can see that as
demand increases, the demand curve moves farther and farther to the
right on the chart. As it moves farther and farther right, the point at
which the demand curve crosses the supply curve also moves higher
and higher. This tells you that increasing demand for a currency
increases the value of that currency.




                                                                          10
Demand for an exporter’s currency increases as importers from one
economy buy goods and services from exporters from another
economy. For example, when importers from the U.S. want to buy
goods from Japan, they must buy those goods in Japanese yen (JPY). In
other words, U.S. importers must buy Japanese yen (JPY) so they can
buy Japanese goods. This increases the demand for—and thus the
value of—Japanese yen (JPY).




How Increasing Supply from Importers Affects
Currency Values
Increasing supply of a currency decreases the value of that currency.

Looking at the supply and demand chart below, you can see that as
supply increases, the supply curve moves farther and farther to the
right on the chart. As it moves farther and farther right, the point at
which the demand curve crosses the supply curve also moves lower and
lower. This tells you that increasing supply of a currency decreases the
value of that currency.




                                                                           11
Supply of an importer’s currency increases as importers from one                 position of the country in question, but also the strength of economic
economy buy goods and services from exporters from another                       activity abroad. Trends in import activity reflect the strength of
economy. For example, when importers from the U.S. want to buy                   domestic economic activity.
goods from Japan, they must buy those goods in Japanese yen (JPY). To
obtain the money to buy Japanese yen (JPY), U.S. importers must first
sell U.S. dollars (USD). They can then use the proceeds from the sale of         Typically, a nation that runs a substantial trade balance deficit has a
their U.S. dollars (USD) to buy Japanese yen (JPY). This sale of U.S.            weak currency due to the continued commercial selling of the currency.
dollars (USD) increases the supply of—and thus decreases the value               This can, however, be offset by financial investment flows for extended
of—U.S. dollars (USD).                                                           periods of time.




Trade Balance
The trade balance is a measure of the difference between imports and
exports of tangible goods and services. The level of the trade balance
and changes in exports and imports are widely followed by foreign
exchange markets.

The trade balance is a major indicator of foreign exchange trends. Seen
in isolation, measures of imports and exports are important indicators
of overall economic activity in the economy.

It is often of interest to examine the trend growth rates for exports and
imports separately. Trends in export activities reflect the competitive




                                                                            12
13
Disclaimer
None of the information contained herein constitutes an offer to purchase or sell a financial instrument or to make any investments.
Saxo Bank A/S and/or its affiliates and subsidiaries (hereinafter referred to as the “Saxo Bank Group”) do not take into account your
personal investment objectives or financial situation and make no representation, and assume no liability to the accuracy or
completeness of the information provided, nor for any loss arising from any investment based on a recommendation, forecast or other
information supplied from any employee of Saxo Bank, third party, or otherwise. Trades in accordance with the recommendations in an
analysis, especially, but not limited to, leveraged investments such as foreign exchange trading and investment in derivatives, can be
very speculative and may result in losses as well as profits. You should carefully consider your financial situation and consult your
financial advisor(s) in order to understand the risks involved and ensure the suitability of your situation prior to making any investment
or entering into any transactions. All expressions of opinion are subject to change without notice. Any opinions made may be personal
to the author and may not reflect the opinions of Saxo Bank.

Please furthermore refer to Saxo Bank's full General Disclaimer: http://www.saxobank.com/?id=193




                                                                   14

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FOREX - CAPITAL AND TRADE FLOW DRIVE CURRENCY VALUES (3.1)

  • 1. Chapter 3.1 Capital and Trade Flow Drive Currency Values 0
  • 2. In this section, you will learn how the following affect the supply of and CAPITAL AND TRADE FLOW DRIVE demand for a currency: CURRENCY VALUES Supply and demand are the simple concepts behind all price movement Contents in the forex market, and no two fundamental economic indicators are Capital Flow better suited to measuring supply and demand than are capital and trade flow. Trade Flow Capital flow measures the money that is flowing in and out of an economy for investment purposes—like buying stocks and bonds or merging with or acquiring another company. Trade flow measures that money that is flowing in and out of an economy for the purchase of tangible goods and services—like cars, electronics and professional services. As money, whether it is for investments or for goods and services, flows in and out of an economy, the supply of and demand for that economy’s currency rises and falls. This causes the value of that currency to rise and fall as well. 1
  • 3. CAPITAL FLOW Money crosses borders every day in ever-increasing amounts. Globalization has made it easier and easier for investors to put their money to work in virtually any economy around the globe, regardless of where they live. Investing in stocks on the New York Stock Exchange (NYSE) or the NASDAQ is just as easy as investing in stocks on the London Stock Exchange (LSE), the Frankfurt Stock Exchange or the Tokyo Stock Exchange. Global investors have an impact on the levels of supply and demand for currencies around the world. Let’s take a look at how the actions of these investors influences the value of a currency. Here you can see a typical supply and demand chart. Demand is represented by the line that is sloping downward from left to right, and supply is represented by the line that is sloping upward from right to left. The point at which these two lines cross represents the price the market will accept for the currency. 2
  • 4. The flow of capital from one economy to another affects the currencies of the two economies involved in the exchange. Take a look at how the following can impact the value of a currency: - Increasing demand - Increasing supply - Decreasing demand - Decreasing supply 3
  • 5. How Increasing Demand Affects Currency Values Increasing demand for a currency increases the value of that currency. Looking at the supply and demand chart below, you can see that as demand increases, the demand curve moves farther and farther to the right on the chart. As it moves farther and farther right, the point at which the demand curve crosses the supply curve also moves higher and higher. This tells you that increasing demand for a currency increases the value of that currency. 4
  • 6. Demand for a currency increases as investors move their money from another economy into the economy represented by that currency. For example, when investors in Japan want to buy U.S. government bonds, they must exchange their Japanese yen (JPY) for U.S. dollars (USD). This increases the demand for—and thus the value of—U.S. dollars (USD). How Increasing Supply Affects Currency Values Increasing supply of a currency decreases the value of that currency. Looking at the supply and demand chart below, you can see that as supply increases, the supply curve moves farther and farther to the right on the chart. As it moves farther and farther right, the point at which the demand curve crosses the supply curve also moves lower and lower. This tells you that increasing supply of a currency decreases the value of that currency. 5
  • 7. Supply of a currency increases as investors move their money from the economy represented by that currency into another economy. For example, when investors in Japan want to buy U.S. government bonds, they must exchange their Japanese yen (JPY) for U.S. dollars (USD). This increases the supply of Japanese yen (JPY), which decreases their value. How Decreasing Demand Affects Currency Values Decreasing demand for a currency decreases the value of that currency. Looking at the supply and demand chart below, you can see that as demand decreases, the demand curve moves farther and farther to the left on the chart. As it moves farther and farther left, the point at which the demand curve crosses the supply curve also moves lower and lower. This tells you that decreasing demand for a currency decreases the value of that currency. 6
  • 8. Demand for a currency decreases as investors stop moving their money from other economies into the economy represented by that currency. For example, when the Bank of England (BOE) lowers interest rates, U.K. government bonds become less appealing to foreign investors because they offer a lower rate of return. If foreign investors do not want to buy U.K. government bonds, they do not need to exchange their currency for British pounds (GBP). This decreases the demand for—and thus the value of—British pounds (GBP). How Decreasing Supply Affects Currency Values Decreasing supply of a currency increases the value of that currency. Looking at the supply and demand chart below, you can see that as supply decreases, the supply curve moves farther and farther to the left on the chart. As it moves farther and farther left, the point at which the demand curve crosses the supply curve also moves higher and higher. This tells you that decreasing supply of a currency increases the value of that currency. 7
  • 9. Supply for a currency decreases as central banks increase reserve two economies involved—and supply and demand drive currency requirements to pull money out of circulation. For example, when the prices. U.S. Federal Reserve increases reserve requirements for its member banks, it tells them that they must keep more of their money in reserve Here you can see a typical supply and demand chart. Demand is instead of lending it to borrowers. This makes it more difficult for represented by the line that is sloping downward from left to right, and corporations and individuals to borrow money, which effectively supply is represented by the line that is sloping upward from right to reduces the amount of money that is in circulation. left. The point at which these two lines cross represents the price the market will accept for the currency. Trade Flow Chances are if you look at the electronics, toys and clothing you bought during this past year, you will find they were made somewhere outside of the country you live in. Global trade has blossomed, and it is now possible for virtually anyone to eat bananas from South America on dishes from Europe while watching a television made in China. Trade flow between economies affects currency values. Every time goods or services exchange hands, money also has to exchange hands. European importers have to exchange money to buy goods from Japanese exporters just as Japanese importers have to exchange money to buy goods from European exporters. Each time importers exchange money, it affects the supply of and demand for the currencies of the 8
  • 10. Take a look at how the following can impact the value of a currency: - Increasing demand for the exporter’s currency - Increasing supply of the importer’s currency Plus, you can monitor what affects trade flow may be having on the currencies you are trading by watching perhaps the most important trade-based fundamental economic indicator: trade balance. 9
  • 11. How Increasing Demand from Importers Affects Currency Values Increasing demand for a currency increases the value of that currency. Looking at the supply and demand chart below, you can see that as demand increases, the demand curve moves farther and farther to the right on the chart. As it moves farther and farther right, the point at which the demand curve crosses the supply curve also moves higher and higher. This tells you that increasing demand for a currency increases the value of that currency. 10
  • 12. Demand for an exporter’s currency increases as importers from one economy buy goods and services from exporters from another economy. For example, when importers from the U.S. want to buy goods from Japan, they must buy those goods in Japanese yen (JPY). In other words, U.S. importers must buy Japanese yen (JPY) so they can buy Japanese goods. This increases the demand for—and thus the value of—Japanese yen (JPY). How Increasing Supply from Importers Affects Currency Values Increasing supply of a currency decreases the value of that currency. Looking at the supply and demand chart below, you can see that as supply increases, the supply curve moves farther and farther to the right on the chart. As it moves farther and farther right, the point at which the demand curve crosses the supply curve also moves lower and lower. This tells you that increasing supply of a currency decreases the value of that currency. 11
  • 13. Supply of an importer’s currency increases as importers from one position of the country in question, but also the strength of economic economy buy goods and services from exporters from another activity abroad. Trends in import activity reflect the strength of economy. For example, when importers from the U.S. want to buy domestic economic activity. goods from Japan, they must buy those goods in Japanese yen (JPY). To obtain the money to buy Japanese yen (JPY), U.S. importers must first sell U.S. dollars (USD). They can then use the proceeds from the sale of Typically, a nation that runs a substantial trade balance deficit has a their U.S. dollars (USD) to buy Japanese yen (JPY). This sale of U.S. weak currency due to the continued commercial selling of the currency. dollars (USD) increases the supply of—and thus decreases the value This can, however, be offset by financial investment flows for extended of—U.S. dollars (USD). periods of time. Trade Balance The trade balance is a measure of the difference between imports and exports of tangible goods and services. The level of the trade balance and changes in exports and imports are widely followed by foreign exchange markets. The trade balance is a major indicator of foreign exchange trends. Seen in isolation, measures of imports and exports are important indicators of overall economic activity in the economy. It is often of interest to examine the trend growth rates for exports and imports separately. Trends in export activities reflect the competitive 12
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