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    Question ID:   5648         Current Version: 1
Question: What determines the value of a currency?
Category: Business & Finance > Economics
Keywords: CPI, determine, value, currency
Type: what
Rating:(0 ratings)    Views: 445    Discussions: 0   In Watch Lists: 1  

 
    Answer:

The value of a currency can be viewed from a domestic as well as an international perspective. Domestically, we use measures such as Consumer Price Index (CPI) to measure changes in the purchasing power of the dollar over time. When the CPI increases, we say that the dollar is buying less - the value or purchasing strength of the dollar is going down. If the CPI is relatively stable, we say that the value of the dollar is stable. For some products with falling prices, we can even say the purchasing power of the dollar is increasing.

Even though the dollar may be stable domestically, the value of the dollar could be rising or falling as measured by another country's currency. In those cases, a currency is a commodity. It is something that has a price and is bought and sold in order to be used. The medium of exchange used to purchase this commodity is the currency of another country. The dollar, in that perspective, is purchased by foreign citizens who will, in turn, use it to purchase U.S. goods and services or dollar-denomicated assets such as Treasury securities, corporate or municipal bonds, or stock.

Almost every international exchange of goods and services requires the exchange of one currency for another. Less frequently, some countries will barter goods, or settle payments in gold. But most international transactions involve foreign exchange. The individual, firm or government of another country that wants to buy U.S. products needs dollars. This is because the dollar is legal tender in this country and all transactions tend to be denominated in dollars.

The dollar, of course, is not the only currency that is bought and sold, but it is among the most popular. Other important currencies include the Japanese yen and the German deutschmark (sometimes referred to as the d-mark).

Sources:

Strong Dollar Weak Dollar: Foreign Exchange Rates and the U.S. Economy, Federal reserve Bank of Chicago

 

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