Currency, in todays world, is one of the most accepted forms of money in circulation today. Used as a tool for exchanging goods and services, currency is an important asset in everyday commerce. Value is easily traded with the help of currency. But is currency itself value? If so, why is it valuable? Isn’t it just a pretty piece of paper or some digits on a screen?
As I sit here and ponder this subject, I find myself going back and forth, unable to come up with a solid position as to whether or not currency, in of itself has value. If you have read my explanation about goods and services, you will learn that true value is something that helps sustain and or enhance the lives of people. That’s what goods and services does. But does currency sustain and or enhance the lives of people? Yes I know, it would definitely depend on the person spending the currency. But in general, in the broader scheme of things, does currency in of itself offer value or in other words, sustains and or enhances the lives of people?
After much thought, I feel comfortable saying yes. Currency does have value because it usually enhances the lives of those who use it. Currency is a service. If you are employed, you buy the possession of currency by selling your time and skill. Please note that I said that you buy the possession of a currency and not the ownership of a currency for a currency is owned by a central bank and not by you. Now that you have possession of currency, you have the option to sell that currency for some other form of value. It is in the selling process where currency provides a service for you. Currency is assisting in the fulfillment of a transaction, aiding in the trading of values. It is in that perspective where currency has value.
Various Currencies with Various Valuations
There are numerous currencies in circulation today. The United States dollar, European euro, the Japanese yen and others are only some of the various currencies out there. Though they are all currencies, they vary in value. Some currencies are more valuable than other currencies. If they are all currencies, why do they have varying values? That question that crossed my mine in the early stages of my research regarding currencies. Allow me to introduce to you the factors that give currency value.
Let me first start by saying that I did not come to this conclusion by any specific third party source but rather through realization and putting the pieces together from all that I have studied and read. There are only two factors that gives a currency its value. Of course I am only talking about a currency that is not grossly manipulated but allowed to fluctuate in value due to market conditions. The two factors that give a currency its value is what I call the quantity factor or money supply and the quantity and quality of goods and services factor.
The Two Factors
- The Quantity Factor
- The Goods and Services Factor
Let me explain what I mean by tackling each factor one by one. In regards to the quantity factor, which can also be known as the money supply factor, the amount of currency available in an economy has a huge influence on the valuation of a currency. The more currency in circulation, the less valuable a currency becomes. When there is too much currency in an economy, the currency undergoes devaluation. If there is too little currency circulating in an economy, the currency will undergo revaluation. The quantity of currency available is a major factor. You can check my article titled ‘The Hidden Factor for Determining Inflation: The Quantity Factor‘ if you want to learn more.
The final factor is the quantity and quality of goods and services which that currency can buy. The more quality goods and services that is available for purchase with a particular currency, the more valuable that currency becomes. The inverse is also true. The fewer quality goods and services that can be brought with a currency, the less valuable a currency will become. The quantity and quality of goods and services factor is just as influential to the value of a currency as the quantity factor.
The Factors Assessed Together
Now that you know the two factors that give currency its value, you need to know the various scenarios between the factors to be able to get insight as to the valuation of a currency relative to another currency. That insight is important for Forex trading purposes. Here are some examples.
If an economy is experiencing economic growth, which means that the amount of goods and services being offered starts increasing at a solid pace and the quantity of currency is being diminished through contractionary monetary policies taken by a central bank, then the value of the currency will increase greatly. Why? Because the amount of goods and services that can be brought with the currency is increasing and the amount of currency available for use is decreasing. That is going to make the value of the currency go up due to the fact that demand for the currency will be going up while the supply for currency is decreasing. Check my explanation about supply and demand. Here’s another example.
If an economy is experiencing economic contraction and the quantity of currency is increasing due to the expansionary monetary policies being implemented by the central bank, the value of currency will decrease. Why? Because the amount of goods and services being offered to the economy is decreasing and thus the currency will be able to buy less because fewer goods and services are being offered. Also, as the quantity of currency increases, the demand for currency will further decline and thus even more lowers the value of the currency.
Now imagine an economy that has very few goods and services available. By default, the currency available for purchasing those goods and services will have a low valuation because there is few goods and services you can buy with it. Why do you think gold is so expensive. Because gold is an unofficial international currency, able to buy every good and service available in the world. Also, the quantity of gold is always limited. That tells you that gold will always have a high valuation for it can buy the all the world’s goods and services and will always maintain a limited quantity.
That’s why quantity of currency and the quantity of goods and services are the factors that give currency value.