How Exchange Rates and Currency Valuations Affect Regular Traders and Investors

Most consumers notice currency values, or exchange rates, when they travel abroad. One year you may find yourself feeling wealthy upon entering a foreign country, but the next year you may find yourself “shortchanged” at customs. How are these exchange rates set, and how do these rates impact trade within Southeast Asia?

Currency Market Basics

Before we cover international trade, let’s explore how and why exchange rates change. There are two basic models to consider: currency values which are pegged and currency values which are floating.

Pegged Currencies

In a country where exchange rates are pegged, the central bank works aggressively to maintain a stable exchange rate between their home currency and a foreign currency. In some countries, this may be a one-to-one relationship between the home currency and a foreign currency.

In other countries, it may be a ten-to-one relationship. For the majority of pegged currencies, this exchange rate is set against the U.S. Dollar or the European Dollar (i.e. the Euro). These central banks influence their domestic exchange rates by buying or selling their home currency in order to tighten or expand their money supply. Lower supply of money leads to higher value of the currency. Higher supply leads to depreciation relative to foreign currencies. China is a major economy whose currency, the Yuan, is pegged to the U.S. Dollar.

Floating Currencies

With floating currencies, the central bank takes a hands-off approach to exchange rates and care more about controlling their domestic interest rates. The central bank allows the open market to determine the value of their home currency relative to foreign currencies. The value of floating currencies come down to basic supply and demand. Factors which can increase the demand for a currency are any activities which require foreigners to buy the currency. This can happen as a result of international trade or increased investment opportunity within a country.

The supply side can get a little bit more complicated, as central banks are charged with printing money. In a strict floating currency country, the central bank will regulate its internal interest rate and money supply to regulate its domestic economic conditions. There are few countries in the world which operate as true floating rate currencies, where the central bank is completely hands-off. In the United States for example, the central bank (also known as the Fed, short for the Federal Reserve) operates a pseudo-floating currency model, but will intervene at times to increase or decrease the money supply.

The Singapore Dollar

In Singapore, the Monetary Authority of Singapore uses a “managed float policy” to guide the value of the Singapore Dollar. Under this structure, MAS allows the Singapore Dollar to trade within a range of values against an undisclosed basket of currencies. In this way, the strategy is partly pegged and partly floating. The approach is more rigid than is found in the United States, but much more fluid than the approach used by China.

How Exchange Rates Impact International Trade

So how does the value of the Singapore Dollar impact trade? Let’s take the example of trade between Singapore and China. This is a very practical example, as China is the leading trade partner with Singapore, accounting for roughly 10.1% of Singapore’s annual export at S$167 billion.

In 2014, 1SGD was worth 5RMB. As of time of writing (24 June 2024), 1SGD is worth 5.37RMB, a difference of 7.4%. For a Singaporean traveller visiting China, the impact may feel quite minimal.

However, the impact can be significant for firms that make large purchases from China or take large loans from Chinese banks. During this time, the value of the Singapore Dollar appreciated by against the Chinese Yuan. Below are two examples of how this would have played out:

• For a Singapore businessman who purchased S$1,000,000 of Chinese goods in 2014, the cost would be 7.4% lower in 2024.
• For a business that paid S$10,000 in interest to a Chinese bank each month during 2014, its interest payment would also decrease in 2024.

Both of these examples highlight the primary way exchange rates impact trade. As a currency loses value, it becomes more favourable for trade partners to purchase goods and services. As a currency appreciates in value, it becomes less favourable for international partners to make these purchases. It may seem counter-intuitive, but it is for this reason that many countries have worked to decrease the value of their home currencies since the 2008 financial crises. Lower currency values mean more export business, higher growth for a country’s businesses, and more income for its citizens.

How Exchange Rates Affects You

Exchange rates will also affect your prospects and cost-benefit analyses if you’re a business-owner looking to expand beyond our shores. Since the Singapore Dollar is partially pegged to the US Dollar, the demand and supply of our domestic currency is thus impacted by the Fed’s monetary policy. This can affect interest rates in Singapore, which then affects the cost of borrowing for, say, your budding business, home down payment and mortgage, or child’s education fees.

What can you as an investor do with this information? Keep an eye on exchange rates in the markets you’re looking to invest in or are invested in, and consistently evaluate your portfolio allocation in terms of bonds and equities you hold in various markets. Maintain a diversified investment portfolio to mitigate risk and avoid putting all your eggs in one basket, so to speak.

Check out our roundup of the best investing tools to diversify your investment portfolio and grow your money today!

Read More:

• Guide To Foreign Exchange Rates And International Remittance
• Investing 101: A Basic Guide to Forex Trading
• 5 Causes of Inflation & How They Affect Forex Rates
• The Beginner Investor’s Guide to Trading Platforms
• Guide To Foreign Exchange Rates And International Remittance

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