If I want 500€ I need to pay 6000 SEK. What is it that decides which currency is the strongest? Like in Sweden the SEK is reaaally low right now. Why?
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Imagine that your neighbor had his own home made currency. He borrowed $500 US from you and then drew a $500 of his neighbor bucks on a napkin and handed it back to you and said you were now even.
Basically, it’s all made up. “Value” is a subjective concept. There is a system that decides these things but that system was also made up, and constantly changes because it isn’t real or tangible, to give power and control over monetary value. Basically, there isn’t a system in place that isn’t there for the few to control the many.
Countries choose how much money create, and the value is relative to the size/strength of the economy. Think of each economy as a pizza and some countries with the same size pizzas choose to slice their pizza into 6 slices, while others cut it into 8, 10, or 20 slices… size of each slice can vary but that doesn’t tell us much about the size or health of the economy. It’s only whether those slices grow or shrink over time that determines strong or weak economy. Just because the exchange rate is 500:6000 now doesn’t tell us anything, what does is whether that exchange rate used to be 500:5000, 500:10,000 or whatever.
It really has nothing to do with how much currency a country prints, or how much money is in a given financial system at all.
What actually determines the value of one currency (say, the Krona) relative to another (say, the Euro) is how many Europeans want to buy Swedish goods and how many Swedes want to buy European goods. When a Swede wants to buy something in Europe, she needs to trade in her Krona for Euros, and vice versa when a European wants to buy something in Sweeden. If more Swedes want Euros than Europeans want Krona, then the Krona becomes weaker relative to the Euro because the Swedish Euro-buyers are all competing against one another for the available Euros, driving the price of a Euro (in Krona) up.
It’s worth noting that a given currency is only strong or weak relative to another currency, not in any absolute way. It’s totally possible for the Krona to be weak against the Euro but strong compared to the Yen or the Dollar.
It’s also worth noting that strong and weak aren’t value terms. A weak currency, in other words, is sometimes desirable for a country. If the Krona is weak relative to the Euro, then it’s comparatively cheap for Europeans to buy Swedish goods – good news for Swedish businesses. At the same time, it’s bad news for Swedish customers of European goods.
It’s tough to think of supply, demand and prices for currencies because you measure prices in… currency. It’s weird. I find it easiest (and ELI5 appropriate) to think of currencies as tokens for an arcade.
Imagine you live in a town with three arcades. Each arcade sells their own tokens, but only a limited amount – maybe a few thousand every 3 months. If you can’t buy your tokens directly from the arcade, you have to hope that someone else in town has tokens to sell to you.
Now, which tokens would be the most expensive? If one arcade had the best games, then their tokens might be more expensive. If another arcade gives better prizes for winning games, their tokens might be more expensive. At the end of the day, though, the *price of the tokens is determined by how many people want to play at each arcade*.
That’s how exchange rates work: instead of arcades, we have economies; instead of games, we have investments; and instead of prizes, we have returns.
If a country has a strong economy that people want to invest in, their currency will appreciate (compared to other currencies) – people will be willing to pay more for the tokens that let them invest in that economy. If a country raises their interest rates (“better prizes”) compared to other countries, their currency will appreciate.
There are other effects this analogy covers, too: a lower exchange rate (cheaper token) helps a country with their exports (i.e., if all three arcades have the same game, people will be more likely to play the game at the arcade with the cheapest tokens); if an arcade issues more tokens, the price per token will fall (all else held equal) because there are more available. If a country goes through political instability (the arcade hires a manager that doesn’t clean the floors and smokes pot all day), the currency will be worth less.
Happy to get more into it if you’d like, but that covers most of the differences between currencies!
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