You can’t determine currency strength from exchange rate
By MUNGAI KIHANYA
The Sunday Nation
Nairobi,
19 January 2020
I was pulled into an
online discussion about the value of foreign exchange recently. It was
started by a person who posted what he said were the strongest
currencies in Africa. The list was as follows: First - Libyan Dinar
(LYD1.41 per dollar); second - Tunisian Dinar (TND2.87); third -
Ghanaian Cede (GHS5.49). Our Kenyan shilling was in 19th
position with an exchange rate of KSh103.84.
He concluded the post
with this comment: “Look at Libya. Look at Kenya. Somebody said
political stability is a major factor for a growing economy. Now I don't
understand”.
My response to this
post was: “what if you put the Japanese Yen in the list - just for
reference. 1USD = 109.81JPY. Does this mean that the KES is stronger
than the JPY?”
The point I was
trying to drive home was that we can’t determine the “strength” of a
currency by simply looking the exchange rate. I had discussed this issue
in more detail almost 13 years ago – in April 2007.
I demonstrated the
point using the price of bread in the USA compared the cost in Kenya. At
that time, 1USD was exchanging at KSh70 and a 400-gramme loaf was KSh25
in Kenya and $2.00 in USA.
Now: I have always
insisted that money has no value unless you spend it. The value is in
what you spend it on. Assuming that the [nutritional and enjoyment]
value of the Kenyan bread is the same as that of the American one, it
turns out that, in 2007, KSh25 bought the same value of product in Kenya
as $2 did in America.
So, $2 was equivalent
to KSh25; in other words, US$1 was equal to KSh12.50. But that was in
2007. Today, bread costs $2.50 in America and KSh40 in Kenya. Thus, the
comparative value is now KSh16 for every US dollar.
Notice that in this
analysis, the foreign exchange rate has not featured at all. In 2007 it
was KSh70 per dollar; and today it is about KSh103. The comparative
value has changed by 28% in favour of the dollar (from KSh12.5 to KSh16)
while the foreign exchange rate has changed by 47%, also in the dollar’s
favour (from KSh70 to KSh103).
It is clear that both
currencies have lost some value over the last 13 years due to inflation
in their respective countries. Of course, it is not good to consider
just one product. To get a clearer picture, we would need to look at the
average inflation rates in these countries during the period and then
compare.
Still, we may want to
compare the movement of two currencies on the foreign exchange markets.
In 2007, one US$ change for about JPY120 and KSh70. Today, the US$
exchanges at JPY110 and KSh103.
Between the yen and
the shilling, which would you say is stronger now? The yen, of course.
It has improved its rate against the dollar while the shilling has lost
significantly.
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