The strength of a national currency can affect the country’s domestic economy and international trade activities in various ways. As a lagging indicator, the implications of a strengthening or weakening currency value might differ depending on the economic conditions as well as the economic policies.

Domestic Economy

Currency strength in the domestic economy refers to its purchasing power over locally produced goods and services. When the economy is stagnant, the central bank can cut the interest rates to reduce currency strength.

Decreasing borrowing costs accelerates production and the national Gross Domestic Product (GDP) grows. Enhanced income and wages of the citizens translate into increased spending and consumer demand, leading to the inflation of consumer prices and allowing the businesses to enjoy higher corporate profits. Expansionary stimulation of the domestic economic activity helps the currency strength to increase in an organic fashion.

However, continuous strengthening of the currency can inflate the cost of living above affordable levels. Salary demands will rise accordingly and the companies won’t be able to sustain profitability with high wages and expansion costs at the same time.

Layoffs will start and lead to higher unemployment rates and causing stagflation in the economy with high inflation and unemployment. The central bank will prevent this by slowing down the economy with an interest rate hike that would increase the currency strength.

International Trade

As the currency strength increases, importers will be able to purchase larger quantities with the same nominal amount or the same quantity with less nominal amount. At the same time, the exporters will enjoy added real value to their nominal income. However, the effectiveness of the currency strength is based on the economic policy adopted by the country.

For example, a country that adopts export-led growth like China would prefer a low currency strength to maintain the cost-effectiveness of the locally produced goods and services and to continue attracting foreign buyers. Thus, a relatively weaker currency will enhance its exports and the Chinese economy will grow by receiving foreign currencies. On the other hand, countries that aim for import-led growth like the US care to have strong currency value which would enable them to enjoy a strong purchasing power that enables to import products in large quantities.