Coin or currency is always worth more than another, as, for example, the dollar is worth more than the Mexican peso; the euro is worth more than the dollar, etc. What is the reason for this situation?
The value of the coins or currencies.
A priori it can be affirmed that the value of a currency depends on the productivity and activity of the country’s economy; The more competitive, productive and stable and strong an economy is, the stronger its currency, it will be worth more, but the matter is more complex.
To fully understand the causes that affect the value of different currencies, you must first know what are the functions of forex exchange reserves (which any country in the world must have if it wants to deal with international payments and purchases of goods). for import).
Economists often argue that currencies (that is, the foreign currencies owned by different national or supranational banks, as in the case of the European Union) fulfill a triple protection function for States and Central Banks: foreign currencies allow to face the country’s short-term obligations, serve as a containment dam against a speculative attack on the national currency and avoid – as far as possible – that the exchange rate varies excessively from the pre-established values.
Taking into consideration that the International Monetary System (which is in charge of regulating the exchange rates of all currencies) must serve to create global means of payment, provide liquidity to the system and correct the imbalances that may occur in the balance of payments of different countries, there are several reasons that explain why one currency is worth more (or less) than another.
Thus, the exchange rate of currencies (which is the price that balances the supply and demand of the currency at all times) is determined by the confluence of several factors:
- Inflation differentials. This means that the currency in whose country there is an inflationary process will suffer a depreciation since its purchasing power will be lower and this will imply an increase in the demand for another currency to buy goods or services.
- The interest spreads. The currency in which the interest rate is higher will appreciate, as the demand for the purchase of this currency will increase from investors from other countries.
- The rate of economic growth of the country. If the national income of a country (which we can call ‘A’) increases with respect to the income of a country (‘C’), the currency of the first will appreciate with respect to the currency of the second, since the demand for the currency of the first country will be greater than that of the second.
- Changes in political and economic expectations. If there are political or economic problems in a country (inflationary spiral, rising unemployment or socio-political instability), its currency will undergo a devaluation process with respect to other currencies.
- Controls by the State. The monetary institutions of the State can cause increases or decreases in the price of a currency, either by imposing or eliminating barriers to trade, either by establishing fixed, flexible or semi-flexible exchange rates between some currencies and others.
If the economy of a country is healthy, if its economic, debt, monetary, fiscal policy, etc., are responsible, its currency will be more stable and therefore stronger, because they provide greater confidence to investors and others. countries.
The price of a currency is also influenced by the political and judicial stability of a country, since they are factors that have an effect on the confidence that third countries and investors have in a country, in its economy, and in their ability to make correct decisions.