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I was just reading about the Dutch Disease and it causes that the value of a country's currency increases when said country suddenly finds natural sources of oil. Why is that?

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  • $\begingroup$ Why is it that someone who wins money in a lottery often worse off in a few years after they win? Economics is about people and human behavior and how other people treat others. $\endgroup$ – JakeGould Nov 26 '15 at 21:44
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How well do you know what you mean with "currency increases"?

The term Dutch disease describes an event where a single sector's boom (your example, finding oil) causes the said sector to grow and other sectors to decline as revenues increase in one sector. The booming sector causes the value of the currency (for example, the Dutch guilder) to appreciate (grow in value) compared to other currencies. This makes exports from non-booming sectors more expensive for other countries and therefore the booming of one sector causes a negative competitive effect on the other sectors.

So the effect is:

  1. Oil is found
  2. Oil (manufacturing) sector booms
  3. Currency value of the Dutch guilder increases as demand for Dutch guilder increases (to pay for Dutch oil. Can cause/be due to an inflow of foreign currencies)
  4. Exports from other sectors become more expensive (due to currency value increase)
  5. Other sectors become less competitive.
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    $\begingroup$ Through the review panel I see that the OP sought to edit his question with this comment: "Why is step 3 true in your answer?" $\endgroup$ – Giskard Nov 26 '15 at 12:36
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    $\begingroup$ Step 3 is true because when supply increases (found new oil), the price of Dutch oil decreases. At the new, lower price Dutch oil is more competitive than other oil, so demand for Dutch oil increases. However, in order to purchase Dutch oil, you must first purchase Dutch guilders (because that is their currency). This causes an increase in demand for the Dutch guilder, so the "price" increases (aka the currency appreciates). $\endgroup$ – DornerA Nov 26 '15 at 16:37
  • $\begingroup$ @DornerA the Dutch did use the guilder as their currency until 1999. Since then, it's been the Euro. $\endgroup$ – EnergyNumbers Nov 26 '15 at 17:32
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    $\begingroup$ @EnergyNumbers, I was just using what was used in the example for the sake of consistency $\endgroup$ – DornerA Nov 26 '15 at 17:35
  • $\begingroup$ @DornerA Your explanation of Step 3 is problematic or incomplete. 1) "Price of Dutch oil decreases" — but oil is a global commodity. The price of all oil would decrease, right? 2) "Dutch oil is more competitive than other oil" — but Dutch disease can also happen in Canada, where Tar Sands oil is less desirable than light crude. 3) "Must purchase Dutch guilders" — but oil is typically traded in US Dollars. $\endgroup$ – 200_success Nov 26 '15 at 19:10

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