NEW YORK (ForexNewsNow) – Some market analyst assert that current decline of the stock market is unimportant, or even positive, for the Forex markets since the fall in conventional stock investments leads people to invest in so-called ‘safe haven’ currencies such as the Swiss Franc and the Yen during economic crises. These analysts argue that economic instability in the stock market actually gives Forex traders an edge, since the potential to profit from strong currencies increases during economic turmoil.
Yet this perspective is both shortsighted and narrow in scope. The decline in market capitalization has many adverse effects for both Forex markets and economic growth as a whole. Here are some consequences of the recent decline in the stock market:
- A decline in consumption: the lower in market capitalization results in higher savings rates across the board. Higher business investment is directly linked to market capitalization, so as the market decline industrial growth potential declines as well, resulting in less investment in the markets as a whole, including the Forex market.
- As the value of all companies, including unlisted ones, fall it increases the chances of a banking crisis with the LBOs since these funds are based on capitalization.
- The movement of funds to ‘safe-haven’ assets that do not participate in growth such as gold, government bonds and currencies (Yen, Swiss Franc etc.) results in less investment in economic growth
- This results in a higher cost of capital for companies seeking to finance themselves on the equity markets.
Thus, the overall growth potential of the economy is strongly affected by the stock market crash and the movement of funds into the Forex market.
Which impact on the Forex markets?
As we have seen while the unstable stock markets paradoxically contribute to the stability of certain currency pairs such as the highly traded EUR/USD pair – both these currencies continue to depreciate against gold, the CHF and the JPY. In addition, the flock of new investment toward safe haven currencies promotes a self-perpetuating cycle of economic instability, as both the Swiss and the Japanese Central Banks must intervene to impose currency regulations in an attempt to stabilize the currencies. Overall, while the current economic turmoil provides many short-term opportunities for Forex traders to profit, in the long term the current trends will have large-scale negative implications for the Forex markets and must be placed into context of the larger systemic health of the global economy, of which the Forex markets only represent a very small part.