3.3.4.6 Setting the Value of Currency
The value of currency can very because it is a commodity that can be bought and sold. It is linked to inflation and affects loan repayments.
Over a period of time, prices of goods and services can rise (or fall). Prices are quoted in the currency of that country, so another way of understanding price rises is to see them as a fall in the value of the currency. This is what is commonly called inflation and it has to be taken into account in management of the economy, as discussed later (3.3.8.3).
A currency is a commodity. This can be clearly seen when considering what is happening when one changes pounds into dollars, for example. There is a price – the exchange rate – for how many dollars can be bought for a pound, which varies according to market perceptions of the strengths of the American and British economies in this case. If the pound depreciates in value against the dollar, someone in Britain would have to pay more in sterling than previously to buy the same goods or services from America.
Currency traders set the exchange rates between the two currencies, and there is an active market in currency futures. The futures market offers a way for a business to safeguard itself against the risk of a currency value changing between the time of placing an order and the time when payment must be settled. That risk is then transferred from the business to the currency trader, who must assess the relative strengths of the two currencies involved when forecasting what a future exchange rate might be.
Lenders in financial markets are taking a risk that loan repayments, in whatever currency had been agreed with the borrower, might be worth less by the time that the repayment is received if the value of currency has depreciated. This is a very significant risk if the loan is over a long period, as is often the case with government borrowing (3.3.8.1) for example, so the lenders charge a higher interest rate (‘yield’) if they consider that the economy is weak.
This page is intended to form part of Edition 4 of the Patterns of Power series of books. An archived copy of it is held at https://www.patternsofpower.org/edition04/3346.htm.