How can we increase wealth using fundamental economic concepts about the forex market?

Fact 1

The US dollar has been depreciating against the major currencies in the world over the last few decades. This is mainly due to the rising imports in the US and hence the increasing supply of US dollars in the forex market.

Fact 2

Australia is well endowed with natural resources such as minerals, metals and fuels. Therefore, the exchange rate of the Australian dollar depends to a large extent on the exports of these resources.

Note: The two facts above will be explained in greater detail in economics tuition.

Prediction

Suppose you predict that the world economy will move into a recession soon.

Question

How can you make use of these facts and prediction to increase your wealth?

Answer

Well, you can convert your savings in Singapore dollars to US dollars. If the US economy moves into a recession, the imports will fall which will lead to a decrease in the demand for foreign currencies. When this happens, the supply of US dollars will fall which will lead to a rise in the exchange rate. These will lead to an increase in your wealth (which will be in US dollars) in terms of Singapore dollars.

The story does not end here. If the US economy moves into a recession, so will the world economy. When this happens, the world demand for resources will fall which will lead to a decrease in exports in Australia and hence the demand for Australian dollars resulting in a fall in the exchange rate.

However, we have learnt from history that no recession will last forever. Suppose that you predict that the US economy and hence the world economy will recover soon. What can you do to increase your wealth further?

Well, you can convert your savings in US dollars to Australian dollars which should be pretty cheap by then. As the world economy picks up, the world demand for resources will rise which will lead to an increase in exports in Australia and hence the demand for Australian dollars resulting in a rise in the exchange rate. When this happens, your wealth (which will be in Australian dollars) in terms of Singapore dollars will increase further.

A check with statistics will confirm that this simple way of increasing wealth works. Of course, predictions can go wrong. However, this problem is by no means peculiar to economics. Taking calculated risk is part and parcel of life. Remember, even if you keep your money under your pillow, your pillow may catch fire!

What I find interesting about this simple way of increasing wealth is that it does not require you to be a financial genius. Rather, all that it requires of you is an understanding of some fundamental economic concepts, and of course, some patience.

The story, however, does not end here. Think about what will happen and how you should response when the Fed starts to tighten monetary policy when the US economy recovers, assuming the monetary policy used to deal with the recession in the US was more aggressive than in other economies.

Mr. Edmund Quek will provide a more elaborate explanation in economics tuition.

Economics Tuition Singapore @ Economics Cafe
Principal Economics Tutor: Mr. Edmund Quek