Eli5 How the value of a nation’s currency is determined?



Like why can’t some country say something like “our country’s currency value will be 200 times that of US dollars ” . And who determines this value or how it is determined. And why it constantly changes.

In: Economics

The value of money is determined by the demand for it, just like the value of goods and services. When the demand for Treasurys is high, the value of the U.S. dollar rises. The other way is through foreign exchange reserves. That is the amount of dollars held by foreign governments.

It’s based on a number of factors, the largest of which is confidence/faith. If a country’s banking system looks like it’s having problems or might have problems, this will cause the relative value to fall.

The next ones are industrial output, how much “stuff” is that country making or providing as a whole. A country that is providing nothing has money that nobody is terribly interested in because, well, there’s nothing to buy in that country.

Value is determined by people. How much faith people have in said currency. People will lose faith when a country goes into debt and has to print billions/trillions to cover debt payments and other expenses, which is a reason why many are concerned about inflation (de-valuing) of the US dollar right now.

There are examples in history of inflation and hyperinflation that can be Googled quite easily.

Sure, Randomistan could say “our currency is now: 1 of ours to $200USD.”

But if that value isn’t realistic, no currency traders will engage in transactions and Randomistan will be screwed. And no/minimal tangible goods traders would trade with them either.

If Randomistan tries to price their currency way out of what it should be, no one will sell them food/oil/raw materials/etc. at the price they want, and vice versa.

Picture your street with a bunch of garage sales. Got a bunch of them all selling KidToy1 at $3, except that one guy down the street with an overgrown lawn and rundown house is selling KidToy1 for $25. Who’s going to buy it from him at $25 when they can get it for $3 next door?

> “our country’s currency value will be 200 times that of US dollars ”

They do. This is called “pegging” and is a fairly common practice. However, it does come with risks: if the currency you’re pegging to changes in value in a way that’s harmful to your economy, there’s not much you can do about it.

It depends on the policy of the country and the free market. Currency derives it value from the goods they can be exchanges for. If one country sells a car for 200 and another sells it for 100, if that exchange rate isnt a 2:1 (all other things equal), then there would be an arbitrage opportunity (ie someone didnt do their research and underpriced their currency or product relative to the market)

>Like why can’t some country say something like “our country’s currency value will be 200 times that of US dollars ” .

They can. But to what end? Let’s say you have some country whose unit of currency is the *foo*. Right now, 1 foo = 1 dollar. And let’s say that 1 foo/dollar can buy 1 apple.

This country wants its money to be 200 times the value of the dollar so it decides to come up with a new currency, the *bar*. 1 bar = 200 foo = 200 dollars. Everyone exchanges their foos for bars.

But what has changed? If I had 200 foos before, I now have 1 bar. But I’m just as “rich” as I was before. I can’t buy any more apples than I could have before. It’d be like if you went to your bank and exchanged 10 one dollar bills for 1 ten dollar bill. It doesn’t make you ten times richer, you’ve just swapped one currency for another.

>And who determines this value or how it is determined.

In a free market, the value of the currency is determined, more or less, by supply or demand. The value of an object in currency is determined by how much of that currency people are willing to give up in order to obtain that object.

Theoretically, a government could ban all export/import, forcibly set all prices and wages, but then you’ve completely removed yourself from world economics and your nation’s currency really wouldn’t have a comparison since it is completely isolated. Not to mention that such an economy would be doomed to fail.

>And why it constantly changes.

Because supply and demand changes, the cost of materials and labor changes, technology makes things cheaper but then produces more advanced more expensive products, natural and man-made events affect supply chains, hurt or promote businesses. The economy is a dynamic system that is always changing because people and the world is always changing.

Anyone can print out some shoddy custom bills on their printer and claim they are worth 200 times the USD. The problem is to find someone who actually wants to buy these bills at your high price. The traditional way of doing this is to build a strong economy built around this currency and produce a lot of valuable goods that you export to other countries. But in order to export these goods people need to buy your currency using for example USD in order to buy the products they want from your country so they can export it. But be carefull because people might want to import goods into your country and they will have to offer a better price in order to get their hands on USD to buy things abroad. However the more modern way of making a currency highly valuable is to post about it on reddit claiming it is going to be the peoples currency to fight against the evil millionare. This is a very fast way of getting to be one of those evil millionares yourself as you were the one who made the currency in the first place or at least bought a lot of it early on and are able to sell it at a much higher price. If you are clever though and already a super billionare with your own space project then you can just mention the currency on twitter and see the price go up as all the gullable followers want to get rich too, so you sell the currency to them and then in your next national public speaking event you talk trash about the currency so you can buy them again at a low cost. This is of course all tax free since you are using offshore proxy accounts. I am not saying anyone have ever done something like this but that would be a very good way of making money.

You can actually do this. China did it for a long time, it’s generally referred to as currency manipulation. What everyone above said is correct except in the instance where a government has near total control over the economy. In the instance of China, the Communist system gave the government the ability to artificially adjust the value of the currency.

To me, the more interesting question is why would you want to do this? In China’s case, keeping the value of the yuan artificially low meant that Chinese exports became much cheaper than the market would otherwise dictate. There is a lot more to it, but it is a big factor in why “everything is made in China”.

Modern currency are backed by the economical might of the Nation issuing them. the reason why you dont have nations going :

“our country’s currency value will be 200 times that of US dollars ”

is because: unless this nation has 200x the productivity and economical might of the US, no one will take that claim seriously and trade with that nation at that absurd rate because no one reasonably believes the country is worth that much in the market..

at the end of the day: a currency is only as worth as your country’s ability to back its value up.

something as simple as a bill is nothing more than a promissory note that says: “at any point you can come to a bank and trade this note for x value”, if people dont have trust in this promise, they simply wont trade with you in that currency.

The short answer is “free-market supply and demand sets the prices.” However, countries do have some tools to control the value of their currencies in relation to other currencies.

* They can expand the supply of their currency (and lower its relative value) by printing more money. This is called inflation. It’s generally a bad situation to be in, but sometimes it’s the only way to get out of an even worse situation (like having tons of foreign debt that you cannot pay).
* They can abolish the currency, and start over with a new one, usually allowing everyone who holds their old currency to trade it in at a rate like 100:1 or 1000:1 for the new currency. This is called “currency devaluation,” and it’s basically like doing a whole bunch of inflation all at once. This messes up their economy pretty bad, but again, it’s a tool that can be used to get out of an even worse problem. It can get them to a new controllable stable value level instead of an uncontrollable inflation spiral.
* They can also reduce their money supply (and increase its relative value) by a number of means. By reducing the rate of new money printing; by offering government-backed securities that must be purchased with their currency (like US Treasury Bonds); or by raising taxes and reducing government spending to stockpile the surplus tax revenue.
* Keep in mind that governments have the power to create “demand” for their own currency, by requiring their citizens to pay taxes, fees, public services, etc. only in their domestic currency. Raising taxes, or tightening up the laws on what can be paid for with foreign currencies, can help increase and stabilize the value of their currency. Of course, these moves have their own economic and social consequences, that the government will have to deal with.

In addition to these indirect methods, countries often *do* try very hard to directly manage the exchange rates between their currencies and and others. Often, they will have an official exchange rate, and the government will only “sell” its foreign currency stockpiles for domestic currency at that official rate.

This can be a helpful tool to try to manage inflation, but if the official rate gets too far away from the actual free-market value of its domestic currency, then people just stop using the government exchanges and start up black markets. This is what’s happening in Venezuela right now, [for example](https://www.thebrokebackpacker.com/changing-money-venezuelas-black-market/).

Through the power of [Imagination](https://i.pinimg.com/originals/69/34/46/6934463e4edf171dd1f771664a199253.jpg). And I wish that was a joke but it’s not.

The “value” of a nation’s currency is dependent on many factors.

If you think of a “new” country creating a new currency, you can look at the US. If you’re making a new currency, you have to decide who controls it, who prints it, and how it is taxed first. If it were simply based on how much of it exists, then any new bills printed would devalue it, since things which are more rare are more valuable to get, but that limits its usefulness as a currency. Consider a country of 1000 people. If you printed ten “dollars” then how can 1000 people best use that ten dollars? There needs to be enough of the currency for people to actually use it.

Then there’s taxes. If you print paper with numbers on it, who cares? Well, if you’re a government and you say certain business trades are taxed in the denomination ot the new currency, it creates a demand for that currency because in order to do business within that govt’s jurisdiction, you need that currency to pay those taxes. That is how you create a demand for that currency in an economy.

Next, there’s the question of who controls the creation and distribution of that currency. Banks have historically served this purpose for the most part, but this is just a convention – it’s just one way people decided how to issue new money into the economy, usually through loans, but that has implications as well, as far as who gets loans, what amounts, and what methods of repayment exist, and who gets to take profits from the effort and how much in profits?

Finally, there’s the question of comparing different currencies.

Basically, you have to figure out the local relative value of one currency vs the other. If one economy has 100,000 people and $10,000,000 in currency, and another has 1000 people and $10,000,000 in *their* currency, what are the values of the different currencies to each other? It’s hard to say without more information, but the economy with 100,000 people likely has a stronger currency *if* that currency is used well and makes those people prosperous, because it is serving more people. But you also need to consider the standards of living and real effects of the economies – people’s happiness and life expectancy, for example, among other things.

These are the broad considerations on a philosophical level. In practice, there are technical issues that people use as proxies (substitutes) for these values. Things like “interest rates” and “GDP” and other stuff helps to quantify these ideas, though they are flawed and incomplete.

So a nation can do things to make their currency, at least temporarily, valued at a certain multiple or fraction of another currency, but depending on the economies and autonomy of the people within those economies using that money, this artificial declaration may or may not hold well.

It’s very complex for an ELI5 but I hope this helps some folks.