The movement in the forex trade is easy to understand. All you need is a basic understanding of the importance of the forces of demand and supply which are there even in our daily lives.
This is illustrated here using Japan as a case point. Oil prices are a major factor influencing exchange rates in Japan. If the demand for this commodity goes up, the prices will also skyrocket. This makes related fuel products to also start retailing at proportionally high prices. Products such as gasoline and natural gas are examples of these related products.
This makes driving to and from town for work very expensive. As a result, your budget will be greatly affected. Large corporations are also affected in the same way. This ultimately forces the government to pay higher prices for oil imports. It should be noted that Japan get almost 100% of its oil needs from importation. It therefore must buy oil at the prevailing prices. The result of these actions is that oil plays a major role in the fluctuation of the exchange rate of the Japanese yen.
In the same way that Japan depends on imports of oil products to drive its electronics and motor industry, the same way it depends heavily on the export proceeds from these finished capital goods. It becomes expensive to run industries due to high cost of fuel, and it also becomes expensive to transport these goods to consumers. This forces computers and DVD players from Japan to retail at very high prices.
The effects of these high costs have negative economic effects on all the players. To begin with, the companies suffer a very high cost of production. This high cost is transferred to the end consumer in the form of high prices. The consumer buys less due to the high prices. The ultimate effect is seen in the exchange rate of the Japanese Yen.
Oil prices are purchased in US dollars. All buyers of oil have to convert their Yens into dollars. As the prices of oil rise, more and more Japanese yen will have to be converted into US dollars in the forex market. This increases the supply of the Japanese yen leading to low value. Also, as the prices of Japanese goods increase, few people will be willing to buy them. This results in decrease in the demand for the yen leading to lowering of its value.
The oil prices in the case of Japan should be taken as just an example of the way in which the demand and supply of goods and services affects the exchange rates in the forex markets. There are many other goods and services that affect the exchange rates of currencies in different countries. Oil is the most dominant good since every country in the world has to deal with oil either as an importer or an exporter.
The illustration of the Japanese example underscores the importance of the US dollar in the forex market. No wonder it is the most traded currency in the international forex trade. From this example, we can also draw a correlation between the strength of an economy and the strength of its currency in the forex trade.