Question

How does speculation in currencies affect the value of a nation’s currency?

Answer 1

There is currency speculation if someone buys a foreign currency, not because they have to pay for an import or invest in a foreign company, but because they intend to sell the currency at a higher rate in the future (the currency "appreciates" in the technical language). This is nothing more than the old law of low buying and high selling – except with foreign currency.

The number of currency transactions directly related to trade and investment is called the "main market of exchange," since it is connected to the sale of specific goods and services. Nonetheless, most currency trades do not take place in the main market, but in the secondary or speculative market through which five times as much money changes hands as it does in the main.

In layman's terms, this means that currency speculation is important for importers, exporters and investors, and that more speculation is usually better than less. The more currency speculators are active in the secondary market, the simpler it is for traders and investors to buy and sell foreign exchange while trading.

Given this rosy picture, currency trading may interfere with foreign trade and economic growth. Currency speculators engage in a "guessing game" about whether a currency will rise (appreciate) or fall (depreciate) in value. Speculators use techniques to mitigate their risk, which they hope will make their guesses more accurate. These involve collecting information about what makes for a healthy economy (often from skewed sources); following certain, especially big, speculators' actions; and using "forward exchange" markets. Both of these approaches may entail self-fulfilling prophecies that trigger financial instability, and may prevent governments from introducing a sustainable economic policies.