I’m reading about the changes in values of currencies at the moment, and I struggle to understand:
How are the values of currencies determined in relation to one another (e.g. EUR to GBP or GBP to USD), and why are some “stronger” than others?
I don’t understand why the GBP would be the strongest (or so it seems to me), followed by the EUR (although it’s recently been supplanted by the USD), and then the USD? With USA being the top economy in the world, and things like oil and gas traded in USD, why isn’t the USD the highest valued currency?
In: 3
When developing a currency there is an inherent advantage for a country that relies on imports to have a higher comparative value currency, and an advantage for an export country to have a lower valued currency. Using the US as a standard middle point things often pan out with this.
Let’s say it takes $1 USD of material to make a PB&J sandwhich. Congrats we have now pegged the USD to the PB&J standard. Now let’s go to Penutville where the cost of materials to make a PBJ is significantly cheaper due to all of the cheap peanuts, costing $0.5USD, but for those in Peanutville that is equivalent to 1P (1 peanut buck). Now let’s have the USA AND peanutville begin to trade PBJs with each other with $0.1USD taken up by transportation/etc, no other trading happens. Both value it at 1 of their currency, but the costs are significantly lower in Peanutville.The midway point after expenses between the two is $0.7USD, so let’s look at that impact. USA is now importing it and everyone gets to enjoy cheaper PBJ, the money saved from the cheaper PBJ can be used to buy other things, yay! Peanutville gets to export at a profit using the extra money to buy other things, Yay! Both parties are happy.
The midway point after expenses between the two is $0.7USD, over time Both currencies will converge and hit this point of equilibrium, and once that happens there is no longer an inherent savings/profit from a currency side of things.
Wasn’t life better when USA made savings and Peanutville made profit based on their differences? Instead of tying our currency to a strict PB&J standard let’s try to maintain the difference of our currencies through other means, like USA printing less cash, or Peanutville printing more cash. let’s balance some things out by including other nations and other trade goods.
Now let’s step back to reality, the UK and the EU import more than they export compared to the USA, so overall it is a net benefit for them to aim to have a higher relative currency value. Why is the Euro falling below the USD? They like the higher relative as it helps on imports, but now the cost of the imports has dramatically rose, and like a dam emptying it’s reservoir its using their initial currency advantage to purchase those goods. As the currency continues to drop the financial pains from importing will increase, but on the flip export industries get a relative boost.
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