Economics & Foreign Exchange

The profits derived from investments are ultimately completely derived from the economic cycle. A booming economy encourages discretionary spending and profits for industries based on indulgence spending. Certain asset classes and certain businesses are better held during these cycles. Alternatively, a sluggish economy usually has low or little discretionary spending, and “safe haven” assets and industries humans cannot survive without performing better as investments.

The value of a currency is based on the demand for that currency relative to other currencies, or currency substitutes like bitcoin and gold, in the international market. This demand is directly affected by the economic strength of the underlying economy since fiat currency values are backed by the underlying economy relative to inflation or deflation incurred.

The economy gives a nation’s government the ability to pay its debts via earnings from taxed revenue, without relying solely on printing money or increasing the national debt in absolute terms or as a percentage of GDP.

Economic Cycles

GDP typically rises and falls in a pattern associated with the “economic cycle”, also called the “business cycle”. “Expansions” in the business cycle increase GDP, and it eventually tops out in a “Peak”. After the peak comes “Contractions” and GDP growth rates fall.

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Inflation/Deflation

Currency values are also affected by “Inflation” and “Deflation”, which affect the purchasing power of that currency. If a nation’s currency is “inflating” it is losing purchasing power. Each individual unit of currency can purchase less. If a nation’s currency is “deflating” it is gaining purchasing power, each unit of currency can purchase more.

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Real Gross Domestic Product

A nation’s economic strength is measured through output called gross domestic product. Focus on the inflation adjusted “Real Gross Domestic Product”. When Real Gross Domestic Product (Real GDP or RGDP) rises, the nation’s output has increased since the last time it was measured. When Real GDP falls the nation’s output has decreased.

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Central Bank Mandates

Central Banks try to keep their economy within a stable target range of economic growth. This is called a “mandate” and possibilities include Inflation, GDP growth, or Employment levels. One individual mandate prioritized over others by each Central Bank, but Inflation is most common.

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Central Bank Tools

Central banks have a set of tools that they can use to accomplish their mandates. The usage of these tools varies in suitability and preference by the central bank. Certain tools are more likely to be used in certain situations than others. The tools consist of roughly six options.

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Major Central Banks

Each of the world’s major central banks are different. Each currency has a central bank which manages and controls its currency. The job of the central bank is to stabilize the currency, while growing the economy for the people. Most focus on stabilizing inflation around a set range level.

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Economic indicators come in three different time categorizations. The first is “leading” indicators, which correlate to trends in GDP and inflation up to a year and a half in advance. the second is “coincident” indicators, which lag leading indicators and are typically used to show how the economy is performing now. The lagging indicators include GDP and Inflation.

When trying to predict economies, look at leading indicators. To determine which indicators are leading, look at their trends in expansion and contract months in advance of Real GDP expansions and contractions. If indicator expansions and contractions are strongly correlated to GDP and lead by a large time difference, the indicator is leading. If the indicator’s trend turns with GDP, the indicator is “coincident”.