Have you ever wondered what causes the rise and drop in commodity prices? While there are several factors at play, the most significant cause is the fluctuating value of a country’s currency.
We’ve seen this happen with our own rand in the past few months as our currency has tumbled and gained momentary reprieves, so has the price of certain commodities.
As things currently stand our currency is doing better than it was in January of this year, but with the ominous threat of ‘junk status’ around the corner we can’t be sure what the future holds – and the recent political instability poses some unknowns. However… if the political decisions move in a constructive democratic direction, our Rand will strengthen.
So what causes a currency’s value to fluctuate?
There are quite a few factors at play. These are just a few of them:
- Trade balance is one of the main factors. The trade balance helps to understand the strength of a country’s economy in relation to other countries. This is based on the calculation of a country’s exports minus its imports. When a country’s imports exceed its exports, the subsequent negative number is called a trade deficit. When the opposite happens, a country has a trade surplus.
- Another factor is the political climate of a country. Political stability, especially in emerging economies is very important. But not just in emerging economies – look at what happened in the UK in the wake of Brexit. A political decision to leave the EU ended up having huge ramifications on the pound.
- Inflation also plays a part. If your inflation rate is very high, then the value of your currency is going to be eroded. South Africa’s inflation rate is relatively high compared to the US.
Countries like South Africa operate a flexible exchange rate system, which means the value of the rand is determined by the market forces of supply and demand. In some other countries, like the United Arab Emirates, they have fixed exchange rates. Such countries, mainly oil-producing countries and ones with small populations, have very stable and predictable economies.
The strength or weakness of a currency always reflects on the prices of goods.
If commodities are imported for manufacturing processes, then the cost of finished products will be significantly higher in a country with a weaker currency. However, if the country is producing more raw materials and goods locally, there’s a better chance of keeping prices stable and inflation low.
The moral of the story from this blog…? Local is lekker!