Government Influence
The government of a country, or the Federal Reserve Bank in the case of the United States, is able to control the value of their currency. In the US, this is done by issuing Treasury Bonds at with higher or lower interest rates. Higher interest rates generate increased demand for American Treasury Bonds.
When foreign entities want to buy Treasury Bonds because of the higher interest rate, they must first purchase USD (American dollars) with which to purchase the bonds. An increased demand for USD increases the price of USD. Likewise, the Fed (Federal Reserve Bank) can decrease the value of the dollar by lowering interest rates.
The price of a country's currency heavily influences its economy. For example, if USD are very expensive, then foreign entities cannot afford to buy dollars to buy American goods. This makes it hard for American companies to make money because they're unable to sell their products and services outside of the country. In the case where USD is very cheap, American companies will not be able to afford to import materials with which to build their products. If companies can't build products, then they can't sell products.
For these reasons, most governments would prefer to keep the value of their currency relatively constant when compared with the currencies of their major trading partners. This is borne out by an inspection of the USD-AUD exchange rate: $1 AUD is worth $0.8011 USD today (May 6, 2015), and $1 AUD was worth $0.7753 USD ten years ago (May 6, 2005). That represents an increase in the value of AUD relative to USD of only 3.3% over 10 years. That's an annual return of only 0.33%!
Volatility vs. Return
Generally, investments should be chosen with the best rate of return for a given volatility. Volatility is a measure of how much a security's value changes over time. Securities with values that experience large swings in value with regularity are highly volatile. Securities with nearly constant values have low volatility. Bonds are examples of securities with low volatility. Mutual funds have low to high volatility depending on the securities contained within them. Stocks have low to high volatility depending on the company they are for. Generally bonds are less volatile than mutual funds are less volatile than stocks.
| Date | USD per AUD | Growth (Year Over Year) |
|---|---|---|
| 5/4/2015 | 0.785 | -15% |
| 5/4/2014 | 0.927 | -10% |
| 5/4/2013 | 1.032 | 1% |
| 5/4/2012 | 1.019 | -5% |
| 5/4/2011 | 1.076 | 18% |
| 5/4/2010 | 0.913 | 24% |
| 5/4/2009 | 0.739 | -21% |
| 5/4/2008 | 0.936 | 14% |
| 5/4/2007 | 0.821 | 6% |
| 5/4/2006 | 0.772 | -1% |
| 5/4/2005 | 0.778 | --- |
If you look at the USD-AUD exchange rate for the past ten years, you can see that the value of AUD relative to USD is very volatile; half of the years it increases in value, and half of the years it decreases in value. Since AUD is volatile and provides a very low annual return, it is not a good investment. These arguments hold true for all currencies. Currency should not be used as an investment vehicle. In general, currency should only be exchanged when necessary to buy goods or services.
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