Economic Growth and Currency Values

The measure of any economy is how fast or slow it is growing or contracting. When economies are growing, they’re said to be…well, growing. But when economies are slowing, they’re said to be in a recession or even worse, a depression.

Economic Growth

In general, an economy is measured by how productive it is. An economy that produces a lot of goods and services is very productive. Having a productive economy means that people can be paid more, and also that they can buy more. The United States and Europe are some of the most productive places on the earth; as such, Americans and Europeans enjoy lives that are healthy, filled with the necessities, and occasionally marked with excess.

To measure economic growth, economic think tanks publish numbers about a country’s Gross Domestic Product. The Gross Domestic Product for each nation can be explained with this equation:

Consumption + Investment + Government Spending + (Exports minus Imports) = GDP.

We’ll explain each element below:

• Consumption – Consumption is the amount spent on products meant for the end-consumer. If you were to go out and buy a car, for example, then it would go into consumption. However if a car dealer were to go out and buy a car, then it would appear in Investment. The car dealer plans on reselling the car, whereas you intend to make use of it. In developed economies like the US, Australia, and Europe, consumption is the single largest item of them all. When you have a bunch of money, sometimes it just makes sense to make use of it for pleasure’s sake!
• Investment – The investment category is equal to all DIRECT investment by individuals and companies. A direct investment is not a bet on a forex pair, nor is it the purchase of a share of stock. A direct investment is…say, a factory, new building, trucks for a delivery company, or anything that will help a company or person make more money by making a good or service.
• Government Spending – Equal to all the money a government spends in one year. This is the easiest of them all to understand.
• Net Exports – Listed as Exports minus Imports above, the column for net exports is equal to all the stuff that the country sells to people in other countries, minus all the stuff it buys from other countries. For example: if a country sells $100 of stuff to another country, but sells only $80 to other countries, then this column would be equal to negative $20. On the other hand, if a country exports $200 worth of stuff, and imports $40 worth of stuff, then this column would be worth $160. Keep in mind that “stuff” doesn’t just mean things we can hold in our hands—stuff can mean services just as it can mean goods.

Using GDP to Measure Growth

In the next section we’ll show you how GDP can be used to calculate economic growth, which helps us to determine how a currency pair will move in the foreign exchange market