Whether we pull out paper bills or swipe a credit card, most of the transactions we engage in daily, rely on the concept of currency. Money is the lifeline of economies around the world. But currencies are actually only a small piece of the monetary economy and are just one consideration when looking at the total money supply.
Most money today exists as credit money or as electronic records stored in databases in financial institutions. But still, the bread and butter of everyday transactions is currency, and that is what we will look more closely at here.
What is Currency?
Currency first appeared hundreds of years ago as a means of replacing the barter system. Early currencies were "commodity money," which meant that their intrinsic value was derived from the precious metals they were made of.
However, the impracticality of commodity money prompted a shift toward "representative money" – money with no intrinsic value but is backed by the ability to be exchanged for a physical commodity. What if the seller needs some different commodity than what you are giving him?
Money solves this problem. It provides a universal store of value that other members of society can easily access. In general, transactions can move at a much faster pace because sellers have an easier time finding a buyer with whom they want to do business. The gold standard, in which each country's currency is tied to a fixed amount of gold, is the most notable application of representative money.
How is the Value of Currency Calculated?
Money's value, like the value of goods and services, is determined by the demand for it. There are three methods for calculating the value of a currency in the United States:
The first is how much the concerned currency is worth in other currencies. The exchange rate determines this. Forex traders on the foreign exchange market set exchange rates. They consider supply and demand, as well as their expectations for the future.
The second method is the value of treasury notes. They are easily convertible into currencies on the secondary market for treasuries.
The third method is to use foreign exchange reserves. This is the total amount of money held by foreign governments. The more they hold, the less supply there is. This increases the value of the currency. For example, the US dollar would collapse if foreign governments sold all of their dollar and treasury holdings. Money in the United States would be worth a lot less.
There are still universal benchmarks that help determine the value of a currency around the rest of the world. Some of them are:
Interest Rates:
High-interest rates contribute to the development of a strong currency in any economy. This is primarily due to the fact that when foreign investors do business with a country, they receive a higher return on investment.
Economic Policies:
Certain economic policies can help a currency become stronger, but this varies depending on the currency and the country to which it belongs.
Stability:
The more stable an economy is, the stronger it is. When an economy is stable, it invites foreign investors to invest. This increases the value of a currency.
How are Exchange Rates Determined?
While currency technically refers to physical money, financial markets refer to currencies as national economies' units of account and the exchange rates that exist between currencies. Because of the global nature of trade, parties frequently require the acquisition of foreign currencies. When it comes to managing this process, governments have two basic policy options. The first option is to provide a fixed exchange rate.
In this case, the government pegs its own currency to a major world currency, such as the US dollar or the euro, and establishes a fixed exchange rate between the two denominations. To maintain the country's exchange rate, the central bank either buys or sells the currency to which it is pegged.
- A fixed exchange rate's primary goal is to create a sense of stability, especially when a country's financial markets are less sophisticated than those in other parts of the world. Investors gain confidence by knowing how much of the pegged currency they can buy if they want to.
- A floating exchange rate involves allowing the foreign exchange market to determine the value of a currency in relation to the supply and demand for other currencies. Countries with floating exchange rates may experience higher exchange rate volatility, but they also benefit from greater autonomy over their economic policies and trade activities, as well as greater liquidity. The government still intervenes on a regular basis to keep the exchange rate within a reasonable fluctuation range.
Any export/import business, while receiving cross border payments in another currency, has to get it first converted into the domestic currency as per the prevailing exchange rate. If you are a global business with international clients and want to save yourself from the hassles of multi-currency transactions, Salt has you covered. Salt provides the cross border banking services at the lowest rates across 50 countries 24/7.
Currency was once limited to physical coins and bills, but today's digital banking system means that money now exists as data stored in bank ledgers and is even transcending the possibility of tangibility with the development of electronic money like cryptocurrencies.
Many experts believe that the use of electronic money or digital currency is the way of the future. Whatever form it takes, all currency has the same basic goals. It promotes economic activity by expanding the market for various goods. Furthermore, it enables consumers to accumulate wealth and thus addresses long-term needs. We can be certain that the value of the currency, how it is determined, and how we live with it will always change.
