The value of money

[stratego]

How do we determine the value of money in a certain country? Everytime I ask someone this, they just reply "it depends on the country's economic status." But what does that mean? It isn't based on total economic income, because otherwise the British pound wouldn't be worth more than the US dollar. It's not per capita, because otherwise Japan's yen wouldn't be so small. And it's not based on economic growth because in the early 90's China's yuan dropped from 6yuan/ $1 to 8yuan/$1 depite it's economic growth.

 

[Akka]

There is two very different things here : the value of currency, and the value of money. They AREN'T the same.


The value of a currency has NOTHING to do with the value of one unit of it.

That the pound is worth 1,5 $ or 0,01 $ has nothing to do with the real strenght of pound compared to dollar.
The value of a unit of any currency is TOTALLY ARBITRARY. It's decided by the government, which decide that now, this unit will be worth this number of this previous unit.
As an example : in France, in the 60s', the general de Gaulle (who was the president), decided the creation of the "nouveau franc' (new franc), which would be worth 100 of the current franc. It was a totally cosmetic and symbolic change, which affected absolutely nothing beyond removing two zeros from the prices.


The REAL value of currency is it's evolution. A strong currency increases its value compared to others. A weak on decreases. This is decided by the market fluctuation, which represent basically how much faith people have in a certain currency, and how much they think they can win by putting their money in it (depending of the interest rate).

A country with a strong and healthy economy (like Japan was some decades ago), means that its currency won't collapse soon. So it's a good and stable way to put money in reserve.
Another currency can come from a much less stable economy, but have higher interest rates. So it's less safe, but there is more to gain if all goes well. Increasing interest rates is a good way for government to make their currency stronger. But it costs a lot.


As the value of MONEY itself, it represent what you can actually BUY with your money.

If you gain 1000 $ a month, and you live in New York, you're going to be quite poor. Because just renting your flat will eat most of your income (let's say 700 $). Then the food is expensive, and the services in the city are expensive, then what you can get at Wall Mart is also expensive. You will probably have troube just to get what you need to live with so little money.

Now, if you live in Madagascar or Sierra Leone, you will probably pay no more than 100 or 150 $ for your housing. The food will be MUCH cheaper. So as services and goods. The bad side is that you will probably not be able to get the same goods as in NYC, but what you will get will be dirt cheap. With 1000 $, you will spend less than half on what you need to live, all the rest is bonus.

So in both case you get the same salary, but in one case you're a pennyless pauper barely able to feed yourself, in the other you have plenty of money left. So you can say that the "value of money" is higher in Sierra Leone, as you can buy more with the same amount.

 

[cgannon64]

Didn't it used to be based on gold? Like they actually had to reflect the markets? And that $1 was worth x amount of gold, and if the price of gold went up the value of the dollar went up (or down, whatever)?

But they quit taht and now its totally arbitrary?

 

[Akka]

Yup.
Dollar was based on gold, and all other money were based on dollar, at the treaty of Bretton-Woods.

But the USA used this situation to increase the emission of money to cover their deficit, and as such make other countries pay for their own deficit, so in 1974 (IIRC) it was decided that all the money would be totally based on trust, and no more on gold.

(though, I believe there is still a percentage of the total money that must still be based on the reserve of gold, but I may be wrong)

 

[ArbitraryGuy]

In a simplistic neoclassical, long run model...

Money Stock and Money Demand determine the "value" of money (i.e. nominal price level). Nominal exchange rates (the exchange rates you see in the paper) are related to relative prices among countries and real exchange rates (determined by Net Exports and Savings/Investment Differential), along with speculation (that has a lot to do with the country's economic status).

These days the dollar is purely fiat money, with no gold to back it up.

 

[EdwardTking]

Money is merely the longest lasting confidence trick in the world.
It was invented about 3,000 years ago by the Lydians who lived in what is now West Turkey.

The value of money is all an illusion.

Like the Emperor's New Clothes.

It has a value because people believe in it.

If people stop believing in it, money will have no value.


Communism in the USSR collapsed when the soviet leadership ceased to believe in it.

If the people in the West stop believing in money, it will have no value.


That will almost certainly happen, probably the day after I win the state lottery.

 

[ainwood]

Its set by supply and demand.... If a country has a positive climate for investment, then people will wnat to invest in that country. To do this, they will need to buy the currency of that currency - this creates a demand, and hence pushes the value of that currency up.


On a tangent - it annoys me when advertisers use relative values of currency to create an illusion that says nothing about the relative costs of living: "Families in Somalia starve <because> then earn only $0.50 a day". Well, perhaps $0.50 a day is enough to live on in Somalia :crazyeyes:

 

[Perfection]

Originally posted by EdwardTking
That will almost certainly happen, probably the day after I win the state lottery.

It won't happen, the reason, money is backed! Backed by the usage of government as a form of payment. It's used for salaries and many other things by the government. If you give the government money they will give you services. That's the key, the government and the people who support (I.E. everyone) accept the government promise and backing so it will continue to be used for massive periods of time!

 

[Akka]

In fact, saying that money will disappear if people stop in believe in it, is exactly like saying that government and institution will disappear if people stop believing in it : it's true, but it won't happen

 

[jack merchant]

Akka pointed most of it out already, but really, there are two ways to look at the value of a currency: there is the internal value (you are an American holding x amount of dollars and we're trying to determine how much you can buy with it inside the US) and the external value (the exchange rate; holding the same amount of dollars, how much can you buy with it outside of the US ?).

The internal value of the currency mostly depends on the local price level, i.e. inflation (or money demand/supply), which in turn depends on a host of factors, the exact impact of most of which most economists don't generally agree on. The exchange rate tends to depend on relative interest rate, inflation and expected changes in them. An exchange rate can be 'fixed' vis-a-vis another currency or (usually) gold, but that will last only as long as the FX market decides it's realistic to.

 

[IceBlaZe]

What decides the exchange rates? or who?

I keep seeing 'em change continously on finance websites.
How are they determined? Who determins them?

 

[jack merchant]

Broadly speaking, the market. To determine the exchange rate, you have to assume that the return of investments in any one currency would need to be the same (why hold pound sterling earning 3% interest when holdings of dollars might earn 5% for example ?). So people look at the real interest rate in countries (the real interest rate is the risk-free interest rate minus inflation). If the real interest rate is higher in one country than another. the value of the currency of the first country will go up (people will buy that currency as they can earn a higher return on it) and the other currency will go down. However, one factor you need to add in is the expectation of what happens to the value of the currency in the near future; if a currency is widely expected to go depreciate in value, that hurts the value right now too (I'm now realizing I better dig up my copy of Krugman & Obstfeld's International Economics and Internation Trade though - I've gotten a little rusty in this matter here).

 

[Archer 007]

Does anyone find using paper to control our lives as rather funny?

 

[Octavian X]

Of course it is. Our wellbeing revolves around a seemingly useless amount of paper, and a useless number kept by a bank. It's enough to make an outsider without this type of system laugh.

 

[Pontiuth Pilate]

...This planet has, or had, a problem, which was this. Most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movements of small, green pieces of paper, which is odd, because on the whole, it wasn't the small, green pieces of paper which were unhappy. And so the problem remained, and lots of the people were mean, and most of them were miserable, even the ones with digital watches.

 

[onejayhawk]

Originally posted by archer_007
Does anyone find using paper to control our lives as rather funny?

If you really think so, watch the reaction of a crowd when the person on stage burns a $20 bill. When you think about it, its a cheap demonstration, but it will totally freak some people out.

BTW if you think its based on paper, consider that 99% of the money in the world exists only numerically, as ledger entries, in a computer often enough, and has no paper to back it.

J

 

[Archer 007]

Which is even odder to think about.

 

[Goober]

Money?!?!

What is this strange thing you call "Money"?!?

If you are talking about that handy-dandy little Swipe-Card, then I might know what you are talking about (Gotta Love Interac . . . )

 

[vonork]

Originally posted by onejayhawk
BTW if you think its based on paper, consider that 99% of the money in the world exists only numerically, as ledger entries, in a computer often enough, and has no paper to back it.

Want to have some fun, creat a virus that takes out all Data-records, that would produce interesting times.

Or only something that takes down communications on the market, there are large banks that trade in short with billions of dollors to keep a volum - if that is lost they lose kredit and go bankrupt.

 

[Stapel]

supply and demand. That easy it is!