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 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.
Latest Answers