The $5 trillion trap - and how to bridge it

The $5 trillion trap - and how to bridge it

Every day around $5 trillion is traded in foreign exchange. While much of it is speculation (trading only for the sake of making a profit), foreign currency transfers are essential to enabling global trade and remittances keep families, and in some areas countries afloat.

There are many factors driving foreign currency values. Fundamentally, however, it is at a macro level about the supply and demand of currencies.

But there are a lot of factors that go into driving the fundamentals.

For instance, currencies appreciate and depreciate for a range of speculative reasons, as seen by the recent implosion of the British Pound following the Brexit vote. Likewise, the election of Trump is affecting the value of the Mexican Peso because of his unmeasured rhetoric on remittances and NAFTA.

And it gets even more complex.

Inflation rates affect the exchange rate. A sustainable low inflation rate, a sign of a strong, predictable economy, typically sustains a stronger currency.

Interest rates can affect the value of a currency. Higher interest rates typically strengthen a currency by increasing demand for it, because borrowers pay higher interests, thus attracting more foreign capital.

A country’s balance of trade and earnings influences the exchange rate. Deficits usually depress the value of the domestic currency due to the potential instability and associated economic performance.

Public foreign liabilities also influence the currency rates. Investors may opt to sell their public bonds when the debts are too high. This leads to a fall in demand for the currency, thus depressing the value.

Also, exports and imports influence exchange rates. So does the political status of a country. Just as a well-established and stable economy strengthens a currency, so does strong, transparent and predictable political leadership.

A recession tends to weaken currencies. This tends to play out over chapters. Economic weakening is typically accompanied by reducing interest rates, which in turn attracts less foreign capital thus generating less demand for the currency. That in turn, raises the cost of imports putting even greater pressure on the economy. The one upside, exports may become cheaper, positively impacting the balance of trade and economic activity.

Indeed, in most cases, all of the forces involved tend to want to balance out any up- or downsides, and a freely trading currency provides a quick and liquid way to address these forces. And if all economic actors had all relevant information and the markets were frictionless, all inputs should be collaborating to seek an equilibrium, even as changes are underway.

But since this is not the case, we have speculation. Speculators act on the information they have trying to anticipate where the market may move to. By trading currencies, they seek to extract a profit for correctly anticipating any movement among currencies.

In recent years a group of banks which get together twice daily to agree on the new rates of currency were found to have traded on the information they had ahead of sharing said information with the markets globally. Even though the changes were often minute, the unjust profits were significant and have now earned these banks in excess of $10bn in fines, with more to come.

In aggregate, all of the above points make one thing clear: capturing the best rate by trying to time the market or speculating on specific outcomes is for most people probably a guessing game.

There are several simple steps anyone can take to optimise their rate of exchange. By buying currency regularly, say monthly, rather than once a year, you can cost average your rate of exchange, instead of hoping to have bought at the best rate all year. This assures a strong middle of the road rate.

In addition, shop around for the best exchange rate and the best service in terms of transparent, trackable foreign payment services that give you choice and control. And critically, avoid the hidden transfer fees.

By sending your foreign currency transfers With Flash Payments you are able to choose the rate you would like, transparently track the transfer just like a package, avoid hidden fees and complete the whole transaction in almost real-time.

Learn more about Flash Payments and register to benefit from the cutting edge technology, great rates and transparency.