Have you ever wondered how a currency is evaluated? In general, it is the demand for a certain currency that plays a key role in its value. This is just the same way that their demand values goods and services at any given time. When demand is high, it makes sense that the value goes up; however, when demand is low, the value tends to take a nosedive. Money and everyday goods have a lot in common when it comes to evaluation.
There are three ways that currency is evaluated in line with the demand that we outlined above. Let’s take a look at each of these ways in little detail to help us get a full picture of how currency evaluation works. We will also briefly discuss why every one of us should take at least a little interest in currency evaluation.
Three Factors Related To How Currency Is Evaluated
The first way that currency is valued is by looking at how much it will buy in foreign currencies; in other words, we are looking at exchange rates. The exchange rate for currencies is determined by Forex traders on the foreign exchange market. They consider supply and demand and consider their future professional expectations for the said currency. When they collate and analyze all of this information, they are then able to set exchange rates for currencies. This explains why money value can change within just one working day.
The second way that currency is evaluated and reasons why Iranian currency is low is the value of treasury notes. When the demand for treasury notes is high, the value of the currency will increase along with the value. Of course, the opposite is also the case. If the demand for treasury notes goes down, the currency value is also going to be lower.
There is a third and final way that currency evaluation takes place, and this is through foreign exchange reserves. When we talk about foreign exchange reserves, we mean the amount of the said currency held by foreign governments. When they hold a high amount, then it makes sense that the supply is lower. This means that the currency value will go up. However, if, for example, these foreign governments decided to sell all of the said currency, it would bring its value crashing down and be worth a lot less. Hence, foreign exchange reserves indeed play their vital role in currency evaluation.
While these are the three main factors that contribute to how a currency is evaluated, other events or worldwide activities can also play somewhat of a role. For instance, where economies in the world have slow growth, for example, Iran, traders may want to invest in the currency, which seems like the safest haven in an uncertain economic climate; this, in turn, can increase its value. We have certainly seen this in the value of the U.S. dollar. Since the year 2011, it has increased in value even though a high feral debt existed and the economy grew at a slow rate. It was the fact that other economies were even slower in their rates of growth that put the dollar as a safe investment for traders. Hence it became stronger and had a higher value.
Why Is It Good To Understand How Currency Is Evaluated?
You may not be thinking about joining the stock market anytime soon or becoming a dealer in worldwide currencies for that matter; however, having a basic understanding of how currency evaluation works is a wise investment for your time. Currency evaluation affects many aspects of your life, from the amount you pay at the gas station to your weekly grocery bill and the list goes on and on. When producers face extra costs related to currency value going up or down, they tend to pass these on to their customers, meaning you pay that little extra at the gas pump or the store checkout. If you can change your habits while prices are high, you’ll be able to save yourself more than a few dollars. Once prices level out again, you will be able to resume your normal purchase habits.