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How currency value is determined of a country, in Layman’s language

Why 1 USD = 67 INR ? Did you ever think of this ? Why every nation has its currency value? Why every  one wants to earn money in dollars? Why every day the value of a nation’s currency is varying ? Why the value of 1 USD in 1966 was 7.5 INR and why now its so far ? How currency value is determined or decided ? Most of us get this type of questions in our mind. And recently(June’2015) why Greece debt is going to have its effect on other nations like India. And overall how currency came into existence. In this article we are going to have a look at  all these questions and their answers in a simple layman’s language.How-currency-value-is-determined

I was also the one who got all these questions in the mind many times. After finding out the solution to all these , I decided to share it with the netizens who could find it useful and understand well about the currencies.

First of all before demystifying the concept of currency valuation of any nation, we need to have a brief look at the origin of currency to understand well about each and every aspect of currency. So lets explore currency from its birth.

How currency value is determined ?

Understanding the currency From the beginning :

How currency came into existence ?

Every one of us need money to buy goods, property and any other. And how that money matters? In general we often use terms money and currency interchangeably. But in reality money is something that can exist in any form where as currency is commonly accepted form of money i.e., banknotes and coins.

In the early days when there was goods exchange prevailing, people and the traders used to buy goods at the expense of some precious metals like gold and silver. Soon those precious metal coins became the ideal medium of stored value. As the scale of trade and exchanges got increased across distances and quantity it wasn’t practical and safe for traders to carry hundreds and thousands of coins with them. So to simplify that  problem without disrupting trade , the concept of “notes” was created. It was first started in China in 8th century.How-currency-came-into-existence

However these notes needed to be guaranteed by a trustworthy party which is where the banks came into existence. Whenever traders want to trade between fixed locations, banks hold their coins and issue them notes which were accepted by other parties who trusted the banks. The building of trust was therefore the banks job and this led to banks having branches in various cities so they could process trade.

How and Why currency was exchanged among nations ?

After notes came into existence, Banks used to hold the coins of traders and issue them the notes worth of those coins. Say trader “A” who want to carry out the trade with another trader “B” in the same location(nation), can easily carry out the trade with the notes available with “A” as those are going to be valid ones since “B” is in the same location as of “A”.  And if “A” wants to trade with another trader “C” who is of not his location, then “C” cannot accept the notes which are with “A” since his location has some other currency issued by his local bank. So in order to carry out the trade “A” has to get the currency which “C” can accept , i.e., “A” need to buy the currency or deposit coins in banks which can issue notes that are valid in the location where “C” is residing. So this calls for the exchange of currency. Thus currency exchanges takes place in order to carry out the trade.

Currency-exchange

It was in the beginning of currencies where coins used be to deposited to get notes and later on notes became ideal medium of exchange since people started to trust notes. The currency notes will have value until they are trusted by the people. As everyone trusted notes then there arised a question whether is there any need to deposit coins in the banks or the banks should have reserves of gold worth notes? which is known as Gold standard. By  1940 America under the presidentship of Richard Nixon declared that the central banks who issue the currency notes need not have any reserves of gold since everyone trusts the currency notes. But in India it is still assured the reserve of gold. This can be seen from the lines printed on the currency note “I promise to pay the bearer a sum of — ” which assures that it can pay you the gold worth your currency.

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How much currency can a nation print itself ?

One or the other time you might have got this question. So when a country suffers from recession then why can’t it print its own currency and circulate in the country? Doing that is very easy but the problem is every currency will have its value by demand and trust from other people or nations. When a country starts printing its own currency without considering its economic powers, resources, development, its trades and national wealth, soon its going to loose trust from other countries and is going to be black listed. The supply and production of currency in a nation is monitored by central banks or Reserve banks.  In India its RBI which administers and guides the commercial banking activities with a power to penalize and punish fraudulent acts.

How-much-currency-can-a-nation-print

Just like in 2009 how Zimbabwe lost its currency trust by printing directly a 100 trillion-dollar note whose value was even less than a dollar. So any nation can print its own currency as much as it can but doing so causes big recession than not having sufficient money. So it is the trust which makes the currency work and  when that trust is lost then that currency is not more than a tissue a paper.

How currency value is determined of a country?

Every day we see in the business news saying that rupee value got increased or decreased by 20 or 30 or 60 paise. It seems to be very less fluctuation but when we consider it broadly then we can understand how this fluctuation has great impact on the nation’s economic strength. At present US dollar is universally accepted currency due to the relative strength of its national economy. The primary factor for changes in the currency value is trade and exchanges which a nation involves in.

1 USD=INR

Lets say when a nation wants to import crude oil from some gulf country then the importing nation has to pay to the exporting nation in the currency which it accepts. More generally dollar is the accepted currency. So nations like India whose currency is not dollar has to buy those accepted dollars and pay to the exporting country to carry out its trade. There comes the demand for dollars. And these imports and exports are carried out by many nations in various permutations and combinations. Stock markets of nations does the job of looking after trades and exchanges. So the most important factor to improve the value of currency by any nation is to increase its exports and lessen its imports i.e., it has to produce the stuff which other countries need, there by increasing the demand for its domestic currency.

The main reason for Dollar to enjoy its value now is connected with the past 1940’s. It was after the Second World War the only country that was prosperous in the world was the United States. And it was that time where most of the nations were indebted to it in huge amounts or had been devastated by the war. This tangible advantage allowed the US currency to reflect the strength of its nation and since then has continued to remain the most powerful currency in the world as well as the most valuable.

Then(June’2015) Greece crisis has  become a hot potato. Actually the crisis started a long ago in 2010, but it was with the help IMF (International Monetary Fund ), European central Bank and European commission, Greece was able to withstand till now(2015). And when Greece could not pay its $1.7 billion debt to IMF then that results in increase in interests in Europe. As a result there would be inflow or outflow of capital in the nations trading with Europe like India.

So this was the brief story in valuing the currencies of different nations and this is how currency value is determined. Techs Text has almost tried to present the article in layman’s language may be one or two jargons crept in. Also I limited it to be simple and short without lagging much. If you find any part to be modified or need clarity you can let your views through comments. I hope this going to solve your questions regarding currencies. If you like this then share it with your friends too. I look forward to listen your opinions.

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3 comments

  1. Excellent!!! Looking forward to see more informative subjects from you…

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