How is currency valuation calculated? (1 Viewer)

[Missed AB]

This is a carry-over from other threads. We all have discussed the "value" of the dollar. But how is the value determined? I keep reading it is based on US production or output or GDP. But how does that equate to the dollar?

My theory is GDP/ M2 would be an accurate way to calculate dollar strength, and can then use the same formula to compare other currencies vs their respective forward looking GDP.

There are flaws in the actual trending of this theory, but global fiat currency is a new paradigm and I think a lot of money can be made by understanding exactly how to derive the value before it is better trended and understood by masses.

All thoughts welcomed even those from the like of Keynesians.

No racism vs Kenya.

 

[Juiposa]

Normally tacked with the value or gold, or in reference to other currencies, and the total Purchasing Power Parity of a country.

 

[Missed AB]

Normally tacked with the value or gold,

True fiat does not use gold.

or in reference to other currencies

Again there must be some way to derive these "values". 2 green paper is worth 1 blue paper... why?

the total Purchasing Power Parity of a country.

I don't understand your point here? The US can buy more things than any other country, but the USD is not the strongest currency unit for unit.

 

[CalGun]

In some ways it's out of our control. I think it's high and improving due to the failure of other currencies particularly the Euro.

 

[Juiposa]

I don't understand your point here? The US can buy more things than any other country, but the USD is not the strongest currency unit for unit.

PPP is a measure of the purchasing power of a currency versus another against a certain amount of product.

For example, you can by one pound of coal for USD 100, and the same one pound for 3000 Russian Rubles. The PPP of the ruble is vastly lower as it take 30 times more of them to buy the same pound of coal.

 

[Fisher]

That's actually a tough question. Value is relative, but it ends up being a circular analysis in the end, or at least a chicken or egg one. For instance, I was thinking of it in terms of the basket of essential goods over time (the cost of living) but is the cost dependent on the value of the currency or the value of the currency on the cost of producing the basket?

I think in a globalized world with so many variables, it would probably be some pro rata of global GDP and all the various M2's but I am not sure which way to go from there in the reduction. I'll have to think about it some. My starting point is tending toward world M2 in relation to world GDP and figuring out how to get from there to a nation's currency that reflects both the % of global GDP and the % of global currency supply.

 

[Fisher]

At any given time all the money in the world (global M2) is really only worth all the goods in the world (global GDP) so that may be a starting point.

 

[Rainman05]

Value is set in accordance to the money supply out there and in comparison to the rest of the world currencies.

It is set by the national bank (in the case of the US, the federal bank) and it can have different values in different places. It is not an universal.

So for instance, the federal reserve can say that 1$ = 0.771euros .... and the ECB can say that 1$=0.778 euros. Depends on how each bank perceives the other. Same with all the other banks. The reason why some banks have different exchange rates for different currency is because of that. Sure, you will never see Raiffeisen put a value much different than what the ECB estimates. it will be always around that value... but deutschebank may put a different one.

The way you get that equation is by applying certain math formulas which are dependent on certain economic index's and each bank treats each index differently terms of importance.

 

[JP Hochbaum]

Value is perception based so I prefer to not look at the current FOREX valuation of a currency, especially since the Euro is valued higher than the dollar and the Eurozone is in shambles right now.

What I prefer to look at is how much per hour we could purchase in this nation:

 

[Cardinal Fang]

My theory is GDP/ M2 would be an accurate way to calculate dollar strength, and can then use the same formula to compare other currencies vs their respective forward looking GDP.

You would have a decent variable for tracking the national component of exchange rates that include much more. Components for expectations and for international political and financial events would be needed among others to develop any finely tuned instrument. But as a gross measure, GDP/M2 would at least tell you something.

There are flaws in the actual trending of this theory, but global fiat currency is a new paradigm and I think a lot of money can be made by understanding exactly how to derive the value before it is better trended and understood by masses.

"The actual trending"? What is that if not more pseudo-insider-speak? Meanwhile, fiat currencies and floating exchange rates are hardly a new paradigm at this point, and you have little to fear from "the masses" suddenly figuring out how all this works.

All thoughts welcomed even those from the like of Keynesians. No racism vs Kenya.

Kenya is not a race. And of couirse its name has nothing to do with the name Keynes. It is derived from British mispronunciation of the Kikuyu word "kirinyaga" meaning white mountain.

 

[imagep]

At any given time all the money in the world (global M2) is really only worth all the goods in the world (global GDP) so that may be a starting point.

I'm not so sure that would work out. There are a lot of goods, particularly land, which has value, but which isn't exchanged on a freqent basis, thus there wouldn't be a need for enough money to exist to match the value of everything. For my property to be worth $x, there is not a need for someone to hold $X in cash. And money circulates over and over, a small amount of money can result in the creation of a lot of wealth, thus there wouldn't be a need for as much money to exist as wealth. Also, I would think that some additional money has to exist in order to facilitate the trade of services.

I'm not sure that there is any relationship between the amount of goods and the amount of money, but I admit it's a concept that I can't quite wrap my head around.

 

[Cardinal Fang]

Normally tacked with the value or gold, or in reference to other currencies, and the total Purchasing Power Parity of a country.

PPP is a system of alternate exchange rates based solely on the prices of goods and services. If a pound of potatos cost $4.00 in the US and $3.92 in Canada, then the PPP exchange rate for potatos between the two countries would be 1-to-0.98. If you did the same comparison for all goods and services, you could calculate a total goods and services exchange rate which would allow you to estimate the relative standards of living in the two countries. This works better in theory than in practice, but it is still practiced.

 

[Fisher]

I'm not so sure that would work out. There are a lot of goods, particularly land, which has value, but which isn't exchanged on a freqent basis, thus there wouldn't be a need for enough money to exist to match the value of everything. For my property to be worth $x, there is not a need for someone to hold $X in cash. And money circulates over and over, a small amount of money can result in the creation of a lot of wealth, thus there wouldn't be a need for as much money to exist as wealth. Also, I would think that some additional money has to exist in order to facilitate the trade of services.

I'm not sure that there is any relationship between the amount of goods and the amount of money, but I admit it's a concept that I can't quite wrap my head around.

While your point is well taken, it really is just a matter of relativity to other currencies though. When you sell your property that year it would be in play in the currency market but not in other years. There has to be both an a national factor and an international factor to help even out the luxury values where supply is more limited of a product the rarer it is. The Economist tried this once in a round about way in terms of COL based on the price of a Big Mac because of its global availability but failed to account for there are plenty of places where Big Macs are a high-end luxury item and there are places where they may be available but people do not eat cow. GDP/M2 gives you an okay value nationally on a small time frame to offset velocity but it is just a matter of how to interject the supply and value of other nations' currencies into the calculation and using Global GDP is about the only realistic framework in which to do that.

 

[Cardinal Fang]

Value is set in accordance to the money supply out there and in comparison to the rest of the world currencies. It is set by the national bank (in the case of the US, the federal bank) and it can have different values in different places. It is not an universal.

The base exchange rates are not set by anyone. They are detemined in internatinal currency markets and exchanges. As they are continuously changing, they cannot be universal in any temporal sense, but whatever the rate is, it is universally what it is at any given point in time.

So for instance, the federal reserve can say that 1$ = 0.771euros .... and the ECB can say that 1$=0.778 euros. Depends on how each bank perceives the other. Same with all the other banks.

No, you're confusing exchange rates with the buy/sell offers against their inventories that banks of any size make available to the public. These offers are based on actual exchange rates but will include a markup for the more common local currency that allows the bank to make money from the transaction. Buying euros will be a little cheaper in Europe than here because euros are more common there. If the difference were to become too significant however, arbitragers would pounce upon the situation like hungry jackals. Hence, you wont find those circumstances very often.

 

[Cardinal Fang]

'm not sure that there is any relationship between the amount of goods and the amount of money, but I admit it's a concept that I can't quite wrap my head around.

There is a relationship, but isn't 1-to-1. The amount of money must be sufficient to support the exchanges of goods and services that residents wish to make, It is thus associated with the flow of national commerce, not the stock of national wealth.

 

[PeteEU]

Value is determined on many things. There are the basics... wealth, political system, stability, taxes and regulation, value of assets in country and outside country and so on and so on. Then there is image and that is quite important. Is the dollar seen as a reputable currency vs others. And then there is demand and supply.

The reason the dollar has fallen in value is because that is what the Fed wants it to do. It improves (in theory) exports and relative competitiveness. They did this by simply printing dollars.. hence supply goes up faster than demand.

But the reason the dollar has not fallen more than it has, is because of the strong demand and the image of the US as a financial powerhouse. Had it not been this, then the dollar would have fallen much much more and inflation would be up considerably.

In the end the value of a currency is dependent on how the markets trust said currency. If there is no trust then the currency crashes... look at Zimbabwe. The currency there would still have crashed even if they did not go nuts on printing. Or look at the attempts to ruin countries by printing fake bills... the US has done it and others have tried to do it to the US. It is not as effective as one might think, but at some point the point of no return hits and the currency is worthless because you can not trust the bill in your hand.

Even during the gold standard years, the value of a currency was not really determined by the amount of gold a country had, but how much other countries trusted said country's report on the amount of gold they had.

For example, if the US went back to the gold standard, then its value would be based on the perceived amount of gold the US had, and not the actual amount.. since an audit of the gold reserve would never be allowed. Even during the gold standard, the gold reserve of a country was a closely guarded secret and that is one of the reasons the gold standard was "discontinued" time after time again and finally totally kicked to the curb in the 1970s. Basically the official word was that the gold standard was being used.. but in reality it was not and had not been for centuries.

 

[Missed AB]

In some ways it's out of our control. I think it's high and improving due to the failure of other currencies particularly the Euro.

The Euro is currently the strongest currency.

 

[Missed AB]

PPP is a measure of the purchasing power of a currency versus another against a certain amount of product.

For example, you can by one pound of coal for USD 100, and the same one pound for 3000 Russian Rubles. The PPP of the ruble is vastly lower as it take 30 times more of them to buy the same pound of coal.

The valuation of that currency is dependent on a different tract than you are stating.

Coal like most commodities in priced internationally in USD. So the price of coal is dependent upon supply demand. The ruble must then be converted to the USD via FOREX to buy coal. The ruble is not fixed to the price of coal any more than it is fixed to the price of gold. The ruble as you point out has a ration to the USD of about 30:1. One would state this is because of the economic output of the nation backed currency. So how do the markets derive a 30:1 mark for these currencies if the GDP is not 30:1?

 

[Missed AB]

Hey you are figuring out currency is a commodity and will have the same supply demand curve as any other commodity hence inflationary deflationary effects dependent upon supply of that currency.

I'm getting through to you. JP's next!

 

[Missed AB]

There is a relationship, but isn't 1-to-1. The amount of money must be sufficient to support the exchanges of goods and services that residents wish to make, It is thus associated with the flow of national commerce, not the stock of national wealth.

So if it was a formula, how is the Euro, dollar, pound... value calculated? what are the key variables, and how do those variables influence the other variables? What is the calculation that says the Euro is 1.30 vs 1 USD?

I understand it is set by FOREX traders. But what are the yard sticks measuring?

 

[Missed AB]

The reason the dollar has fallen in value is because that is what the Fed wants it to do. It improves (in theory) exports and relative competitiveness. They did this by simply printing dollars.. hence supply goes up faster than demand.

So supply dollars Vs what? equates to the value? Is it GDP? GDP x CONFIDENCE / M2

 

[PeteEU]

So supply dollars Vs what? equates to the value? Is it GDP? GDP x CONFIDENCE / M2

More like GDP + perceived value of country assets + confidence/political stability / M2

For example, in the 1990s Argentina's GDP was rather large and its natural resources are quite considerable and yet no one had confidence in the country for various reasons and the currency tanked. On top of that the Argentinean government printed lots of currency which was to devalue the currency to make them more competitive. That did not work because people had no confidence in the government/country at the time. In the end they replaced the currency and basically went belly up.

 

[Cardinal Fang]

The Euro is currently the strongest currency.

Based on S&P's Greece upgrade and pessimism over Boehner's "cliff" performance? These are the sort of short-term cosmetic factors that briefly entertain markets and bright-shiny-object types and are then forgotten again, having had no actual affect at all.

 

[Cardinal Fang]

Hey you are figuring out currency is a commodity and will have the same supply demand curve as any other commodity hence inflationary deflationary effects dependent upon supply of that currency. I'm getting through to you. JP's next!

You can always tell when you're getting through to me by the peals of laughter on my end. You're not competent in my world.

 

[JP Hochbaum]

Currency is traded as a commodity on FOREX, it is utterly meaningless when buying goods and services that originate from the US. That doesn't make it a commodity in the sense that it has limited capacity, because it's capacity is only limited by the ability to produce more and more things.

As long as we continue to produce, don't print past productive capacity and regulate things enough so the economy runs then the value of the currency will be just fine.