Inflation and Currency Trading

The basic relationship between inflation and currency trading is that all currencies tend to inflate and devalue over time. It is a basic fact of governance that a little bit of inflation makes people happy as it seems to make their property more valuable with time. A lot of inflation gets noticed and tends to cause havoc in a nation’s economy. A high level of inflation affects how people plan their economic lives, make purchases, and save for the future. The basic relationship of inflation and currency trading in foreign currency rates in that the nations that best manage their economies end up with more valuable currencies over time. The basic fact for foreign currency traders in dealing with inflation and currency trading is that betting against a steadily inflating currency is often profitable.

National Policy and Currency Management

Despite the fact that most nations would just as soon not see their currency inflate and devalue, economic and political realities often dominate. If a nation’s balance of trade is constantly negative it leads to a devaluation of their currency versus other currencies. This is seen in the home nation as inflation as more of the local currency is needed to buy a house, car, or loaf of bread. When nations seek to remedy their balance of payments such an action often requires reducing the government’s budget and this means less money in circulation. People often get angry and vote for the opposing party in the next election. This is a simple concept but one that traders must keep in mind when dealing with inflation and currency trading. Foreign currency exchange rates between the United States and Japan moved steadily in favor of Japan for years and years as the USA struggled unsuccessfully to manage its ever mounting budget deficit and balance of payments deficit. Keeping an eye on politics and trade figures is useful in trading one currency versus the other.

A Rising, or Falling, Tide Affects Nearly All Ships

When we consider the US dollar and the Yen we commonly concern ourselves with the balance of payment between the two nations. We also concern ourselves with monetary policy, especially that of Japan. Japan has purchased US dollars for years in an attempt to keep the Yen from getting too strong as an overly expensive Yen would make Japanese imports into the USA too expensive. However, there are outside factors that drive both currencies and relate to inflation and currency trading. And, these factors do not always affect both nations equally. When the price of oil rises it affects Japan and the Yen more strongly. Japan imports all of its oil and imports even more now that it is shutting down nuclear reactors in the wake to the recent tsunami. The USA is a major oil producer and, with the advent of fracking technology, may indeed become energy self-sufficient in a decade or so. This will serve to drive down inflation in the USA. The inflation and currency trading equation could move strongly in the favor of the USA over time. Where this may most strongly apply is in Forex trend trading.