I’m often asked…”How much influence does a government really have over its currency?”
I say, it has tons to do with it. A government really “sets the tone” for its currency in many respects.
How so? Here are seven major ways that I believe a government greatly influences its currency.
7 Ways a Government Influences its Currency!
They set the tone by the policies that they set. Ex. Sarbanes-Oxley has driven money away from the U.S. stock markets and IPO market into other markets, thus hurting the long term prospects for the U.S. dollar. Europe has been more favorable to corporations, so money has flowed there and not to America as much due to this.
They set the tone by what they do with their printing presses. If a government resists the temptation to print tons of money, then it will retain its value. If it “waters it down” by printing tons of it, then it erodes the value of it away. Australia is not quick to print money, yet the U.S. is!
If it encourages “money inflows” into its country through making products that the outside world wants, it ensures inflows into its currency. If it is a country that is heavily involved mainly in the services sectors and itself is a net importer of goods, then there’s huge likelihood that they are setting their currency up for a fall. This is exactly what we have in the U.S.! Yet Australia actually mines and exports many of the world’s most needed commodities: Gold, Copper, Wheat, etc.
If a nation stores up monetary surpluses, it provides a better sentiment for investors and causes “inflows” of money very easily. However, if the country has blossoming deficits, it discourages money flows into the country and actually scares some of it away and prevents other “new money” that would like to enter that country from entering due to them being so worried about their ability to repay their debts. Again, a problem of the U.S. Yet China has huge surpluses.
The ability of investors to trust a government is another huge one. There is a ton of potential money that COULD go into Russia but WON’T go into Russia because you never know what they will do next. Their government is so corrupt and has such a bad image from the outside world of being so shady in their dealings with much of the rest of the world (and their own people/corporations) that it hinders some “inflows” into their currency. Yet Canada and Australia’s governments have great track records.
What a country does with their interest rates has a HUGE effect upon inflows and outflows in a currency. If interest rates are high and headed higher, it generally encourages money to it as investors seek higher yields on their money. However, if a country holds their rates unusually low, then they’re encouraging outflows. Examples of this right now are the U.S. and Japan. Rates are unusually low and thus money is starting to flow away from them once again. Australia and New Zealand were two of the only major countries that weren’t inclined to take their rates near zero percent like most of the rest of the industrialized world, and they have been rewarded the most as things have started to snap back for their financial markets and currencies.
Governments that are “tax friendly” to residents and especially to corporations are likely to see more inflows than those who aren’t. This is why so many companies are moving away from the U.S. as Obama pours on the taxes and they run towards places like Dublin, Ireland. This hurts the dollar and helps the euro!
These are seven huge areas that come to mind where a government plays a huge role in influencing their currency, whether they realize it or not…and many times they don’t (because they’re politicians and not savvy investors!
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