The feel of the currency is the simplest real-time measure of how effectively a country can compete for international trade and investment.
"The currency feels too expensive"
If a currency feels too expensive, a large and sustained increase in the current account deficit can result, and money will start to flow out of the country.
The longer and faster a current account deficit expands, the more risk there is of an economic slowdown and a financial crisis.
Traditionally, that warning light flashed when the current account deficit had been growing at an average rate of 5% of GDP for five years.
But the recent deglobalization of banking has made it more difficult to finance current account deficits, so the new red line may be around 3%.
Beginning or the end of currency trouble, follow the locals
To spot the beginning or the end of currency trouble, follow the locals. They are the first to know when a nation is in crisis or recovery, and they will be the first to move. If the local millionaires are fleeing, so should you.
Once a crisis begins, watch for the current account to bounce back to surplus, which usually means that a cheap currency is drawing money back into the country. It helps if the financial environment is stable, underpinned by low expectations of inflation, which further encourages investors to return.
Meddling by the government to artificially cheapen the currency
If the government tries to artificially cheapen the currency, markets are likely to punish this meddling, particularly if the country has substantial foreign debt or does not manufacture exports that can benefit from a devaluation.
Cheap is good only if the market, not the government, determines the feel of a currency.
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