Why is my currency increasing and yours is going down?
Posted on 16. Jul, 2009 by Stuart in Money
I’m not going to tell you that there are billions of factors that affect your currency’s exchange rate, and that you will never really understand it fully. That would only confuse you. What I am going to tell you is that there are certain simple concepts that, once you get a grasp on them, will greatly increase your understanding of the whole messy situation. You will have a clearer picture in your head, even if it’s not the whole picture.
It all starts with a thing called supply and demand. It’s a law actually, like gravity or attraction—that with few exceptions, the following is true. Supply and demand works like opposite ends of a see-saw. When one goes up, the other goes down.
If I have just one precious toy car (a small supply), I value that toy car a heck of a lot (the demand is high). It’s my pride and joy. I play with it all the time. Now, if my favorite aunt gives me a hundred more toy cars exactly like it (a huge supply), I begin to value each of those toy cars a little less (demand goes down).
It works the same with anything. If I have a thousand Big Macs, I’m more likely to give you a couple than if I only had one (supply high, demand low). If there is only one beautiful girl in the room, everybody wants her (supply low, demand high).
And believe it or not, this works exactly the same with money. Here, I’ll show you.
To start off, let me remind you that someone prints money. It doesn’t just appear. Someone has a big, fancy printer, and whenever they want more money, they fire that printer up and print it out. That someone is the government.
But let’s just say, for the purposes of this illustration, that that someone is me. I have a big machine that prints me as much money as I want. Luckily for you, you’re my friend, and I also give you money whenever you want.
So we have a pretty good thing going for us, you and I, and we go into town whenever we want, and buy a lot of stuff. We love licorice, you and I, so we buy a lot of licorice with our new money.
Like money, licorice also doesn’t just appear. Someone makes it. But soon Mr. Walton at the corner store is running out of licorice. We’re buying it faster than he can get more. Licorice becomes scarce and, because of the shortage, the price of licorice now goes up from $1 to $2. So we now have a lot of money, but it’s only worth half as much as it was before. This is called inflation, and it happens when the government prints too much money.
Now, I’m mad that the value of my money is going down so I stop printing it. Soon we stop buying licorice and poor Mr. Walton, who just got in a huge shipment in response to our demand, now has a whole bunch of candy that he can’t sell. So he lowers his prices and hopes for the best. This is called deflation, or—if it gets bad enough (Mr. Walton goes bankrupt with all that candy that no one wants and has to sell his business)—a depression. These happen when the government slows down its printing of the money.
Simply put, this is why your currency goes up and mine goes down. When I’m printing a lot of my currency, and you’re printing very little of yours, yours is worth more, because there’s less of it. If I slow down the printing of mine but you keep printing yours, people in my country may lose jobs and houses, but the value of my currency will go up, in comparison to yours, because now there’s less of mine.
Photo source: pfala
