The Value of Currency

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1. What “Currency Value” Means

The value of a currency refers to how much it’s worth compared to another currency or what it can buy in goods and services.

There are two main perspectives:

 

Type Description Example
Exchange Rate (External Value) How much one currency can be exchanged for another. 1 USD = 1.50 AUD
Purchasing Power (Internal Value) How much a currency can buy domestically — linked to inflation. $100 buys fewer groceries this year than last.

 

 2. How Currency Values Are Determined

Most modern currencies are floating — their value is set by supply and demand in the foreign exchange (FX) market.
A few are pegged or managed (e.g. Hong Kong dollar pegged to the USD, Chinese yuan partially managed).

a) Floating exchange rates

Driven by:

  • Trade balance (exports > imports → currency demand rises)

  • Interest rate differentials

  • Inflation expectations

  • Investor sentiment and risk appetite

  • Economic growth

  • Political stability

b) Fixed/pegged systems

The government or central bank fixes the rate to another currency (like the USD) and defends it by buying/selling reserves.

 3. Key Drivers of Currency Value

 

Factor How it Affects Currency
Interest Rates Higher rates attract investors → currency appreciates.
Inflation High inflation reduces purchasing power → currency depreciates.
Economic Growth Strong growth attracts capital → appreciation (if sustainable).
Trade Balance Trade surplus (exports > imports) strengthens currency.
Government Debt High debt may deter investment → weaker currency.
Political & Economic Stability Confidence attracts investors → stronger currency.
Central Bank Policy Quantitative easing or money printing → weaker currency; tightening → stronger.
Commodity Prices For exporters (like AUD, CAD, NOK), rising commodity prices → stronger currency.

 

 4. Short-Term vs Long-Term Movements

 

Time Frame Main Influences
Short-term (daily–monthly) Interest rate expectations, news, speculation, sentiment, capital flows.
Medium-term (quarter–year) Inflation trends, monetary/fiscal policy, trade balances.
Long-term (multi-year) Productivity, demographics, current account balance, geopolitical position.

 

 5. How Currencies Are Measured

a) Nominal exchange rate

E.g. 1 USD = 1.50 AUD.

b) Real effective exchange rate (REER)

Adjusts for inflation and trade with multiple partners — a more accurate measure of competitiveness.

 6. Simple Example

Imagine two countries:

  • Country A has 2% inflation and 4% interest rates.

  • Country B has 10% inflation and 2% interest rates.

Investors will move money to Country A, earning higher real returns.
→ Demand for A’s currency rises → A’s currency appreciates relative to B’s.

 7. Current Context (late 2025 snapshot)**

(Approximate global currency trends based on late-2025 data)

  • USD remains relatively strong due to high U.S. interest rates and global risk aversion.

  • EUR has been stable, supported by gradual ECB tightening.

  • JPY has weakened due to Japan’s low interest rates and monetary easing.

  • AUD & CAD fluctuate with commodity prices and Chinese demand.

  • CNY (Chinese yuan) remains managed within a narrow range against the USD.

 8. How to Interpret Value Changes

 

Movement What It Means
Currency appreciates Imports become cheaper, exports less competitive.
Currency depreciates Exports gain competitiveness, imports become more expensive (inflation risk).

 

 9. Summary

 

Concept Definition
Currency value The price of one currency in terms of another or its purchasing power.
Determined by Supply and demand in global FX markets.
Influenced by Interest rates, inflation, growth, policy, sentiment.
Measured by Nominal rate or real effective rate.
Importance Affects trade, inflation, investments, and global competitiveness.

 

 

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