Why is it that the savings-investment imbalances approach to forecasting currency values states that countries with savings deficits will have to have strong currency values to attract foreign capital?
Other way to phrase it is, why will a savings deficit lead to higher currency values? And why will a savings surplus lead to weaker currency values?
A savings deficit (investment > savings) implies that foreign capital is flowing into the country, meaning foreign investors must be purchasing the local currency.
I don’t think a savings deficit in itself causes the appreciation, but if a savings deficit is occuring it must mean that foreign capital is flowing into the country.
So really what’s driving the currency appreciation is the fact that foreign investors are choosing to invest in the domestic economy. If no foreigners were investing, then the amount of investment would be limited to the amount of domestic savings.
Chris - Thanks for your response.
So in this case, does it mean when investments > savings, most of that is attributed to foreign investors? I initially thought the driver of higher investments is due to US based investors and I wasn’t able to make a conclusion on what happens to currency.
So simply put,
–> more foreign capital needing local currency to drive up the currency value?