Course:
Money
Imagine planning your dream vacation across multiple countries, only to realize that the value of your money changes every time you cross a border. One U.S. dollar might get you 90 Euro cents in Germany, but in Vietnam, the same dollar is worth 25,000 dong. What creates these stark differences in currency value? How can something as simple as exchanging money turn into such a complex endeavor?
In today’s rapidly evolving world of finance, understanding the dynamics behind currency value is more important than ever. As we move towards decentralized financial systems like cryptocurrency, the relevance of traditional fiat systems comes under scrutiny. This article will explore the key factors affecting currency value, draw parallels with the crypto ecosystem, and provide critical insights on what these trends mean for the future of money and finance.
The video we’re analyzing offers a clear, foundational understanding of why different currencies have different values. It starts with a simple premise: exchange rates vary due to factors such as supply and demand, inflation, interest rates, and economic stability. The video highlights several key ideas, including:
These foundational concepts help explain why currency exchange rates fluctuate and how macroeconomic forces shape the value of national currencies.
The video provides a strong educational foundation, but let’s critically analyze its arguments. Several compelling points are worth highlighting, as well as some areas where the discussion might fall short or need further nuance.
Strength 1: Clear Explanation of Fiat Money’s Fragility
The video effectively explains how fiat currencies are not backed by tangible assets like gold but rely entirely on government decree and public trust. This raises important questions: What happens when that trust erodes? In countries experiencing hyperinflation, such as Venezuela or Zimbabwe, fiat currencies become practically worthless because people lose faith in their government’s ability to manage the economy. The reliance on fiat exposes economies to volatility based on governmental decisions—making this a particularly powerful point.
Strength 2: The Role of Interest Rates in Currency Value
The connection between interest rates and currency value is a crucial part of understanding how money moves. High interest rates attract foreign investors, who must purchase the country’s currency to invest, driving up demand and value. This is well-articulated in the video, showing how central banks wield significant power over currency strength. But this point could be further enriched by exploring the trade-offs: high interest rates can also slow down the domestic economy by making borrowing more expensive for businesses and consumers.
Strength 3: Country Stability and Investor Confidence
The video touches on the importance of political and economic stability in attracting foreign investment. Investors want to put their money in countries where they can be confident that the rules won’t suddenly change. For example, the U.S. dollar remains strong partly because of the country’s relative political stability and economic power. This insight is valuable, but it could be expanded to discuss how short-term political turmoil (such as a debt ceiling crisis) can create temporary volatility even in stable economies.
Potential Weakness: Lack of Discussion on Economic Manipulation
One limitation in the video’s analysis is the lack of attention given to how countries might deliberately manipulate their currencies. For instance, China has been accused of devaluing its currency to make exports cheaper, giving it a competitive advantage in global trade. This kind of economic intervention complicates the simplistic supply-and-demand model and introduces strategic manipulation as a factor in currency valuation. A more nuanced discussion would enhance the viewer’s understanding of how governments can artificially influence currency strength for economic gain.
Potential Weakness: Over-Reliance on Fiat Systems
While the video rightly focuses on fiat money, it doesn’t explore alternatives in depth. With the rise of decentralized financial systems like cryptocurrency, the fiat model is no longer the only option. Cryptocurrencies, such as Bitcoin, are built on trustless, decentralized networks, where value is determined by supply scarcity (e.g., Bitcoin’s fixed supply of 21 million coins) and market demand. This represents a major shift away from the government-controlled currency systems the video describes, and it would benefit from a deeper exploration of this alternative.
In the world of cryptocurrencies and blockchain, the rules governing currency value differ in some significant ways. Unlike fiat money, cryptocurrencies aren’t controlled by any central authority. Their value is determined by market forces, the technology underpinning them, and, in some cases, the scarcity of the asset itself.
Cryptocurrencies as Fiat Disruptors
Take Bitcoin, for example. Bitcoin is not tied to any government or physical asset. Its value is based on trust in the blockchain technology that verifies transactions and the finite number of bitcoins that can ever be mined. While fiat currencies are subject to inflation when governments print more money, Bitcoin has a fixed supply, which protects against inflation and makes it more appealing as a store of value—often referred to as “digital gold.”
Supply and Demand in Crypto
Like fiat currencies, cryptocurrencies are driven by supply and demand. However, in a decentralized context, demand is often influenced by factors such as technological adoption, network security, and the utility of the token within its ecosystem. For instance, Ethereum’s value is not just speculative; it powers a vast range of decentralized applications (dApps) and smart contracts, creating real-world utility and driving demand for Ether (ETH).
DeFi and Currency Manipulation
Decentralized Finance (DeFi) presents an interesting counter to traditional monetary systems. In DeFi, individuals can lend, borrow, and earn interest on their assets without needing a central bank. This eliminates many of the issues tied to government-controlled interest rates. However, DeFi markets can be volatile, and lack the stability of fiat currencies backed by a central authority. While this volatility presents opportunities, it also introduces risks that fiat currencies are designed to mitigate.
Looking forward, the global financial landscape is likely to be shaped by both traditional currencies and emerging digital assets. The dominance of fiat money, while still strong, is increasingly being challenged by the rise of cryptocurrencies, which offer an alternative to centralized control and inflationary policies.
Potential Shift Towards Hybrid Systems
Some experts predict a future where hybrid financial systems emerge, blending traditional fiat currencies with decentralized digital assets. Governments may issue central bank digital currencies (CBDCs), which combine the trust of fiat with the efficiency and security of blockchain technology. This could change how we think about money, making currency transfers faster, cheaper, and more secure.
The Role of Cryptocurrencies in Global Finance
Cryptocurrencies could also play a role in stabilizing economies with weak currencies. In countries experiencing hyperinflation or political instability, citizens might turn to decentralized assets like Bitcoin as a store of value, bypassing the risks associated with local fiat currencies. This trend is already emerging in countries like Venezuela, where cryptocurrency adoption is growing in response to economic collapse.
From my experience as an educator and expert in blockchain and finance, the most exciting aspect of this shift is the democratization of financial power. Traditional currency systems are deeply intertwined with government policies and institutional control. Cryptocurrencies, on the other hand, empower individuals by allowing them to take ownership of their financial future without relying on intermediaries.
However, we must also recognize that with this empowerment comes responsibility. Cryptocurrencies offer incredible potential but also significant risk due to volatility, regulatory uncertainty, and the lack of consumer protections that exist in traditional banking. Educating the public about these risks, while showcasing the opportunities of decentralized finance, is crucial.
The video on why different currencies hold varying values offers a fantastic introduction to traditional financial systems. By understanding the factors that influence fiat money—such as inflation, interest rates, and country stability—we gain valuable insights into the broader financial landscape. But as the world moves towards decentralized finance, we are witnessing the emergence of a new paradigm where the
value of money is no longer dictated solely by governments but by the collective power of decentralized networks.
As cryptocurrencies and blockchain technology continue to evolve, the future of money is bound to look very different from the systems we know today. Whether you’re a seasoned investor or just beginning to explore these concepts, now is the time to understand how the value of currencies—both fiat and crypto—will shape the future of finance.
Currencies around the world hold different values relative to one another, shaped by a variety of factors such as supply and demand, economic stability, inflation, interest rates, and government policies. To fully grasp these dynamics, it’s important to understand not only how currencies are valued but also the forces that influence these values.
In this lesson, we’ll explore the historical context of currencies, key economic factors that impact their value, and why exchange rates fluctuate. We’ll also delve into inflation, interest rates, the balance of trade, country stability, and the concept of pegging currencies.
Currency exchange rates represent how much one currency is worth in terms of another. For example, 1 U.S. dollar may equal 90 Euro cents or 25,000 Vietnamese dong. These rates are constantly changing based on various factors, including supply and demand and international trade dynamics.
Imagine Bob, an American traveler, who wants to exchange U.S. dollars for Euros when visiting Germany. He notices that his U.S. dollar is worth 90 Euro cents. Later, Bob travels to Vietnam, where his 1 U.S. dollar is worth 25,000 dong. This discrepancy in currency values is influenced by the individual economic conditions of each country and their position in the global market.
Historically, many currencies were backed by gold, providing stability to exchange rates. This system was known as the “gold standard.” Under this system, governments couldn’t print more money than the gold reserves they had, limiting inflation and ensuring stability.
However, as economies grew and global trade expanded, it became harder to maintain this system. By the 1970s, most countries transitioned to fiat money, which isn’t backed by any physical commodity like gold. Instead, the value of fiat money comes from government regulation and public trust in the currency. This system allows governments more flexibility but introduces greater volatility, as currencies are subject to market forces.
Currencies fluctuate in value based on several key factors. Understanding these factors is essential to understanding why some currencies are stronger than others.
The value of a currency is largely determined by supply and demand. When more people want a currency, its value increases. For example, a strong economy like the United States often has higher demand for its currency, making the U.S. dollar more valuable.
Conversely, if a currency is not in demand, its value will decrease. Weaker economies or those experiencing political instability often see reduced demand for their currencies.
Inflation occurs when there is an oversupply of money compared to the goods and services available, causing the currency to lose purchasing power. In high-inflation environments, fewer goods can be purchased with the same amount of money.
For instance, in 2022, you might buy two loaves of bread for $10, but by 2024, due to inflation, the same $10 might only buy one loaf of bread. Countries with high inflation, like Venezuela or Zimbabwe, experience significant devaluation of their currencies because people no longer trust or want to hold their money.
In the 1980s, 1 Zimbabwean dollar was worth more than 1 U.S. dollar. However, due to economic mismanagement and excessive money printing, by the 2000s, 1 U.S. dollar was equivalent to nearly 600,000 Zimbabwean dollars. In the end, Zimbabwe abandoned its currency in favor of more stable foreign currencies, such as the U.S. dollar.
Interest rates set by central banks, like the Federal Reserve in the U.S., also affect currency value. When a country has high interest rates, it attracts foreign investment because investors can earn more on their investments. To invest, they need to buy that country’s currency, which increases demand and strengthens the currency.
If U.S. interest rates are higher than in Europe, investors might sell their Euros and buy U.S. dollars to invest in U.S. bonds or savings accounts, where they can earn higher returns. This demand for U.S. dollars strengthens the currency. Conversely, if U.S. interest rates fall, investors may look elsewhere, decreasing the value of the dollar.
However, central banks must balance interest rates carefully. While higher rates attract investment, they also make borrowing more expensive, which can slow down the economy.
Countries with stable political systems and strong economies tend to attract more foreign investment. Investors seek stable environments where they can be confident that rules and policies won’t change unexpectedly. Countries that experience political unrest or economic instability tend to lose investor confidence, leading to a weaker currency.
For example, a country that frequently changes tax laws or faces protests may drive investors away, weakening its currency. In contrast, countries like the U.S. and Germany are seen as stable, which helps maintain the strength of their currencies.
A country’s balance of trade—the difference between its exports and imports—also affects its currency value. Countries that export more than they import tend to have stronger currencies because other countries need to buy their currency to purchase goods.
Japan is a major exporter of cars. Foreign buyers need to use Japanese Yen to purchase these cars, increasing demand for the Yen and strengthening its value.
Conversely, if a country imports more than it exports, it needs to exchange its currency for foreign currencies, which can weaken its own currency.
The U.S. dollar’s global dominance is partly due to the Petrodollar system, where oil transactions are conducted in U.S. dollars. Since oil is in high demand worldwide, countries must acquire U.S. dollars to purchase oil, further increasing the demand for and strength of the U.S. dollar.
Some countries choose to peg their currency to a stronger, more stable currency to maintain stability. This means their currency’s value is fixed relative to another currency. For example, Belize pegs its currency to the U.S. dollar, meaning 1 Belize Dollar is always equal to half a U.S. dollar.
Brunei, an oil-rich nation, pegs its currency 1:1 to the Singapore dollar. This makes trade and transactions between the two countries easier and ensures stability for Brunei’s currency.
While pegging a currency provides stability, it can make the country dependent on the stronger country’s economy. If the U.S. dollar falls, for instance, the Belize dollar will also fall.
Currency values are complex and influenced by multiple factors, including historical context, inflation, interest rates, political and economic stability, and trade balances. Countries constantly adjust their monetary policies to maintain currency strength, balance inflation, attract foreign investment, and promote stability.
In this lesson, we’ve covered why exchange rates fluctuate, the impact of inflation, how interest rates strengthen or weaken a currency, and why some countries peg their currency to others. Understanding these dynamics is crucial for anyone involved in global finance, particularly in the crypto and blockchain space, where decentralized currencies interact with these traditional economic forces.
This comprehensive guide integrates all key concepts to provide a powerful understanding of why different currencies have different values. By mastering these principles, you’ll gain a deeper insight into both traditional and decentralized financial systems.
This study guide provides a comprehensive overview of the factors influencing currency values, helping you understand the complexities of global finance.
Hey there! This is Bob. He lives in America, where he uses the U.S. dollar almost every day. Now, he wants to travel to Germany, which uses the Euro as its currency. But when Bob tries to exchange his money, he finds that 1 U.S. dollar is equal to 90 Euro cents. Then Bob goes to Vietnam, where 1 U.S. dollar is equal to 25,000 dong. Wait, hold on. Why does money have different values? Why isn’t 1 U.S. dollar equal to 1 Euro or 1 Dong? And why do exchange rates keep changing every second?
In this video, we’re going to dive into the world of currencies, exchange rates, and why money isn’t just… equal!
Before we talk about the reasons behind different currency values, let’s first cover a short history of currency. For a long time, money was directly linked to precious metals like gold. This was known as the “gold standard.” Under the gold standard, a country’s currency was backed by a certain amount of gold. For example, the U.S. dollar was once tied to a fixed amount of gold. This helped keep exchange rates stable because a country couldn’t just print more money without having more gold. It stopped governments from printing too much money.
But as economies grew and global trade expanded, countries started moving away from the gold standard. It was getting harder to keep enough gold to back every unit of currency, especially during wars and crises. By the 1970s, most countries had switched to a new system called “fiat money.”
Fiat money is currency that has value because the government says it does, and people believe it. It’s not backed by any physical asset like gold. That’s why some people call it “fake money.” If you want to learn more about this, let me know in the comment section, and I can make another video on it!
As fiat money has no physical value like gold, its value depends on whether people still want it or not. If many people want the money, they will compete to get it, making the value of the money go up. But if nobody wants the money, its value goes down. So, the value of fiat money comes from supply and demand. That’s why the currency of strong economies, like the U.S. dollar, is higher in value because more people want it. Meanwhile, the currency of weaker economies, like Venezuela, which had hyperinflation, is much lower because nobody, not even Venezuelans, wants it.
Section 1: Inflation
Inflation is when the currency starts losing its value. Simply put, it’s when there’s more money compared to the amount of products and services available. You can watch my video about “Why don’t we just print more money” to understand more about this. When a country has high inflation, its currency’s value decreases. Why? Because nobody wants to buy and hold a currency that is losing value.
For example, in 2022 you could buy two loaves of bread for $10. But due to high inflation, two years later in 2024, you can only buy one loaf of bread for $10. So, you buy fewer things with the same amount of money.
A real-life example is Zimbabwe. In the 1980s, the Zimbabwean Dollar was worth more than the U.S. Dollar—1 Zimbabwean Dollar was equal to 1.35 U.S. Dollars. But due to failed land reforms, economic problems, corruption, international sanctions, and mindless money printing, the value of the Zimbabwean Dollar dropped dramatically. By the 2000s, 1 U.S. Dollar was equal to almost 600,000 Zimbabwean Dollars. The government tried to fix it by changing the currency several times, but in the end, they gave up and started using more stable foreign currencies like the U.S. Dollar and the South African Rand. Even though the latest news is Zimbabwe trying to get back their original currency. So, plus 1 point for never giving up, Zimbabwe!
Section 2: Interest Rates
You might have heard about interest rates before and wondered why they matter so much. Interest rates are the cost of borrowing money, expressed as a percentage. If you borrow $1,000 at a 10% interest rate, you have to pay back $1,000 plus an extra $100 as interest. Central banks, like the Federal Reserve in the U.S., set interest rates in their countries.
When a country has high interest rates, it offers better returns on investments, attracting foreign investors. These investors need to buy that country’s currency to invest, which increases demand and strengthens the currency. For example, you want to invest in government bonds. Government bonds are when you lend your money to the government for a set period of time, and then the government will return your money with interest. Let’s say you buy a government bond for $1,000 with a 5% interest rate for 10 years. It means the government borrows your $1,000 and will pay you 5% interest on it, which is $50 every year for 10 years.
The logic is, the higher the interest rate, the higher the return on investment. So, if the interest rate in the U.S. is higher than in Germany, investors might sell their euros and buy U.S. dollars to invest in American bonds or savings accounts with higher returns. This increased demand for U.S. dollars strengthens the currency. On the other hand, if U.S. interest rates are falling, it offers lower returns, and investors might look elsewhere. This reduces demand for the U.S. dollar, causing its value to decrease.
However, a country cannot just make its interest rates as high as possible to attract investors. Why? Remember, interest is the cost of borrowing money! High interest rates also mean it becomes more expensive for people and businesses in that country to borrow money. If borrowing becomes expensive, fewer people buy homes or start businesses. This can slow the economy and lead to unemployment. So, the central bank needs to increase and decrease the interest rate based on the country’s situation. And that’s why everyone is afraid of this guy when he announces the U.S. interest rate.
Section 3: Country Situation and Foreign Investment
When China opened up its market in the late 1970s to foreign investors, lots of foreign companies started to open their businesses in China. If they wanted to open factories in China, they, of course, needed Chinese currency, which is Yuan or Renminbi, to buy the land, build the factories, pay the workers, and cover other expenses. This increased demand for the Chinese Yuan and made its value stronger, giving China lots of money. That’s why almost all countries promote themselves to foreign investors and lure them to invest and do business in their countries.
But foreign investors won’t just invest in any country. They look for countries with stable politics and economies. Why? A stable government means consistent rules and laws for businesses. For example, if a country promises low taxes to attract foreign businesses but then suddenly raises taxes, it becomes more expensive for those businesses, and they could lose money. If a country keeps changing its rules, businesses won’t feel safe investing there. Similarly, if there are lots of protests or strikes, it can disrupt production and make it hard for businesses to operate smoothly.
A stable economy is also important because it means the country’s money is less likely to lose value suddenly. If a country has a lot of debt, high inflation, or frequent economic problems, foreign investors worry they might lose money. So, a stable country is more attractive for investment, which helps keep its currency strong.
Section 4: Export and Import
When Japan exports cars to other countries, those countries need to use Japanese Yen to buy the cars. This makes the Yen high in demand. If Japan imports coal from Australia, they need to use Australian Dollars to buy the coal, which increases demand for the Australian Dollar. Most countries try to export more so that others need to buy their currency, making it stronger.
For example, when the U.S. convinced oil-producing countries like Saudi Arabia to sell oil only in U.S. Dollars, it made the U.S. Dollar highly in demand. Since almost all countries need oil, they have to get U.S. Dollars to buy it. This made the U.S. Dollar a global currency, strengthening the U.S. economy and influence as the number one in the world. This is known as the “Petrodollar.” Even though there’s a rumor that Saudi might try to accept other currencies also. I can also make another video about it if you want.
On the other hand, small island nations in the Pacific, like Tuvalu, don’t have much to export, so their local currencies aren’t widely used. Instead, they use stronger currencies like the U.S. Dollar or Australian Dollar to make trade easier.
Section 5: Fixed Value
If you want your country to have a stable and strong currency but don’t want the hassle of managing it, you can use this trick: peg your currency to another stronger and stable currency. For example, Brunei, an oil-rich small sultanate in Southeast Asia, pegged their currency 1:1 to the Singapore Dollar. This means both currencies have exactly the same value, and that’s why you can use Singapore Dollars in Brunei and vice versa. Another example is Belize, a small country next to Mexico, which pegs its currency, the Belize Dollar, to the U.S. Dollar. They set the rate so that 1 Belize Dollar is always equal to half a U.S. Dollar. So, if you want to change your U.S. Dollars to Belize Dollars, you don’t need to check the exchange rate—just double the amount. It’s so easy, isn’t it?
Pegging a currency makes it stable and easy to manage, but the country becomes very dependent on the stronger country’s economy. If the U.S. Dollar falls, the Belize Dollar will fall too. So, if one currency “lives,” the
other “lives”; if one “dies,” the other “dies.”
These are some reasons why currencies have different values. Your next question might be: why don’t all countries use the same currency, like a “World Dollar,” so we don’t need exchange rates and all these hassles? Well, it sounds like a great idea, but it’s not that simple.
Let’s look at the Euro as an example. It’s very convenient for people living in the Eurozone because they can travel across countries without needing to exchange their money. But the challenge is that every country has to give up control over its own money to the European Central Bank. This means a country cannot change its monetary policy just to fix its own problems because it could also affect other countries. For example, when Greece had a financial crisis in 2009, the effects spread to other Eurozone countries. And that’s why Germany wasn’t so happy with Greece about this.
If all countries in the world decided to use a single currency, it would be very risky. Imagine living your best life but then facing inflation and a crisis just because a country thousands of miles away messed up its economy. One country’s problem would become a problem for the whole world.
And maybe your next question is, “Should we make our currency as strong as possible?” The answer is, not really. As you know, different countries have different needs. For example, a country that imports a lot, like Singapore, may want a strong currency to make imports cheaper. While a country that exports a lot, like China, may want a weaker currency to make its products cheaper for other countries. That’s why China has been accused of purposely lowering its currency’s value, called currency devaluation. How does this work? I’ll explain it in another video.