Currency

A standard used to denote money or purchasing power parity

Currency is a standard used to denote money or purchasing power parity. Simply put, it is a function of money in a particular nation or the value of a nation's domestic capital.

Currency

Every nation needs to facilitate trade both internally and outside its borders. It facilitates this and plays a significant role in our global economic systems.

Money eliminated the barter system and exchange trading, but a standard unit was still required to suit different conditions and countries.

Every nation eventually created its medium of exchange, and all the trade and commerce were conducted in this unit.

Later, the need for a global medium of exchange arose when the world economy became more interlinked and globalization became a prominent force.

Making this exchange was complicated and impossible as not every nation would participate and fully contribute. However, it would also give some advantages to the richer countries.

Exchange rates resolved this issue. As a result, exchange rates avoid all the problems which traditionally occurred due to unorganized trading systems.

It solved the problems of:

  • I am changing trading amounts due to currency fluctuations.
  • We are increasing the liquidity of all currencies in the open market, thus making the trade benefits for both parties.
  • They are making regulatory compliances like tax regulations and recording the transactions in books of accounts more accessible and consumer-friendly, etc.

A global market was set up to facilitate the exchange of all currencies in circulation on earth, and every coin was given a particular value through which it would be exchanged with each other.

This is how international trade operates today. Economies exchange goods for foreign exchange, a particular amount of the importing nation's notes and coins (or the GRC, i.e., USD) which has the same value as the goods being exported.

History of currency

Almost every nation in this world has a currency they use for trade and commerce in their daily lives. Some common examples are: 

  • the US Dollar
  • the Japanese Yen
  • the Euro
  • the Indian Rupee 
  • the Chinese Yuan 
  • The Russian Ruble etc.

Pile of money

These are the national currencies of some of the biggest economies in the world. The value of each of these currencies is different and constantly changes in the free market.

It is an essential tool, and everyone should work to understand more about global trade and commerce.

The first known currency is believed to be used in Ancient Egypt in Mesopotamia. Rice grains were stored in temple shillings and were used as a medium of exchange, mainly for barter transactions.

Coins in metal pieces were used in India for trade and payments to merchants and the military. Copper was the first metal to be used in the form of coins; silver and gold eventually followed.

The rarity of the metal defined the value of the coin. For example, gold was relatively rare to find compared to copper and silver. Thus it was valued more than the other two. 

It also varied in different regions. For example, in Europe, where silver was abundant because of huge silver reserves, the value of silver was relatively lower.

Bank notes or paper money

The first paper notes resembling instruments were believed to be first used in Ancient China, after the development of their paper technology. They used them as banknotes and trade tools to facilitate exchange.

$100 notes

Banknotes were preferred over coins because coins back then were heavy and hard to carry around. Back then, technology was not advanced enough to have minted small and thin coins.

Paper notes were easy to carry and easy to hide. However, they had a few downsides.

  • Paper notes had no intrinsic value, so that they could be rejected anytime for payment back then. Moreover, there was no governing system for currencies and prices as we have nowadays.
  • Also, governments and rulers can print more into circulation anytime, creating inflationary situations. This causes the money that each individual holds to lose value over time. 

These paper notes took over large hefty coins and became the standard of payments all across the globe. After the governments worldwide somewhat stabilized, trust in fiat money increased manifold.

The gold standard

The gold standard was a system where the values of major currencies were pegged to the value of gold. For issuing new notes and coins, economies needed to keep a fraction of the printable amount as gold reserves in the treasury.

Gold bars

Accordingly, the more gold a nation had, its denominations would have been more vital. Because of this, governments began hoarding piles of gold in their treasury, which eventually led to a shortage of gold with high demand, which caused an increase in gold prices all over the world.

This also imposed many restrictions on printing new money for the government, so they disliked it. 

Additionally, many impoverished nations that had attained independence from colonizations were not in a state to follow the gold standard of the Bretton Woods agreement, so they did not become a part of this system, which made it less inclusive.

The US was the only economy running on the gold standard; no other country had adopted this into full force. 

When the US inflation started rising in the 1930s and the great depression hit the States, demand for cash grew multifold, and the gold standard prohibited the government from printing more money.

Because of this, the US government banned private holdings of gold and made it a licensed-only commodity. This removed the dollar's peg from gold, but in paper terms, everything remained the same.

In the 1940s, after the allied powers won, the US led the allied forces into the Bretton Woods Agreement, which would have pegged each of the allies' currencies to gold. The US was responsible for determining and controlling the exchange rate of gold to USD.

Gold bars

As time passed, gold reserves became harder to find, and world trade grew rapidly, outgrowing the cash in circulation; thus, people needed more money to facilitate global growth and found this pegging system unsustainable. 

The world economies gave up the Bretton Woods system after the US withdrew under President Nixon.

Advantages of Gold Standard

  • It imposed restrictions on printing new money, so the government had to follow those restrictions and not print blind money into circulation as it does nowadays.
  • It stabilized exchange rates of currencies back then as coins used to move 3-4% at maximum in months, unlike now when they are trading at a difference of 3-4% intraday very frequently.
  • It also reduced the fear of demand-led inflation as currency had a substantial intrinsic value over the marginal utility of products.

Printing of notes

Disadvantages of the Gold Standard

  • Not every country had the same access to gold reserves, making it very unfair to many countries with zero to no gold reserves.
  • It imposed hefty restrictions on the government to print more money into circulation, which reduced the ability of central banks to interfere and control economic instruments in a crisis.
  • Gold is limited in nature, and supply-side inflation in a growing economy could put immense inflationary pressures on the economy.

Digital currencies

Dollar symbol

Digital Currencies are an innovation in today's day and age. Since the vast crypto boom from 2008 to 2021, Central Banks worldwide have been on high alert.

They plan to release their digital currencies and impose heavy restrictions on existing decentralized coins.

Cryptocurrencies are decentralized systems of software designed to work on a blockchain technology that keeps a record of transactions made through the denominations in a decentralized database that is not accessible only to the people on that blockchain.

They are believed to be an innovation in how we make payments globally. Currently, they are used chiefly for speculation purposes but potentially have an extensive use going into the future with globalization on the rise.

Transactions made through crypto coins are hard to track as they are fully decentralized, and the governments and central banks have insignificant to no control over them. 

They can reduce the grip that central banks have over the money supply in the economy, which is why they are planning to introduce their coins in the future.

Euro Symbol

Some countries like El Salvador have made crypto their fiat currency. They have replaced all their national denominations with crypto, and they hope that the capital appreciation in the value of these instruments will help grow their economy at a rapid pace.

El Salvador is not the only one to move into this space. The Central African Republic is also a nation that has made crypto its legal tender.

Big economies in other parts of the world are currently experimenting and developing on this issue, and they are going ahead with this quite conservatively.

Countries like China have already started using their digital denominations, the "Digital Yuan." The US's Federal Reserve is also working on the Digital Dollar, which would be pegged to the actual world USD, according to a spokesman at the Fed.

Stack of $100 notes

Apart from all this, digital currencies will restructure a new world order and truly change the world as we know it now, consistently moving us toward a more interconnected world.

What is an exchange, and how are different currencies traded today?

Currencies need to be traded to facilitate international trade. One money needs to be liquid enough, so there is no loss or gain due to speculation during the work.

Currencies

At the time of the gold standard and the Bretton woods system, the currencies were exchanged at a relative value to gold. This was also the ancient system of trade in India and South Asia, where they used silver instead of gold.

Today, all the currencies are traded concerning the global reserve currency or the US Dollar. But how did the US Dollar become a global reserve currency (GRC)?

The USD became a GRC under president Nixon when the US abandoned the Bretton Woods system. The US Government was the most significant institutional single holder of gold reserves anywhere in the world. The USD was believed and is still thought to be the most stable currency in the world.

Seeing the problems with pegging currencies to limited and highly undistributed commodities, many countries then pegged their money to the USD, which is how it became a GRC.

Hence today, every trade between two countries either involves payments in Dollar terms as it is highly liquified, or it is traded according to the value of other nations' currencies in terms of US Dollars.

For example: If two countries, namely Saudi Arabia and Germany, want to trade, they can either make payments in dollars or first have to convert both their currencies in terms of dollar value and then equate the value of that item into their domestic currencies.

A bag of coins

After the trade, a nation trades off the other nation's currency obtained during the transaction and buys either its domestic or the USD. This is facilitated through the World Currency Exchange, where Governments and institutions constantly trade currencies in the open markets.

This is how the value of currencies is determined now, and according to the demand and the supply of these instruments, their value is determined by the open market.

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Researched and authored by Aditya Murarka | LinkedIn

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