What is money and how we perceive it had changed over the past few centuries? There had been many monetary systems in play, but most of them failed after a period, due to wars, economic contraction periods and so forth. Still, since we are forex traders, we might be asking ourselves what gives money to currencies.
Trading forex implies buying and selling currencies, so one currency’s value must increase or decrease in order to make profits. The subject we want to approach today is the value of money and some of the details will definitely manage to impress you.
Does any value exist in currencies?
As we’ve talked in another article related to the history of forex, commodity-based had been in play until a few decades ago. That meant the central bank had a reserve of gold, which was used to back all the circulating money and people, using those bank notes, were able to go at any time to the bank and get gold for them.
However, as the economy was expanding, the demand for money was higher. Central banks found themselves unable to meet the requirements, so the circulating supply of money was not totally covered by the gold reserve.
Since 1982, when the United States defaulted on their foreign debt, central banks had embarked on an inflationary path and what gives money is the demand/supply ratio.
That means the central banks, using interest rates, controls the flow of money into the economy. When interest rates are low, credits are easily available, the money supply increases, which creates an inflationary pressure that leads to the diminishing value and purchasing power of money.
When interest rates are high, credit is not easily available, the money supply shrinks and this creates to deflationary pressure, leading to the rising value of the currency.
As strange as it might seem, what gives value to money is the money that is currently in circulation. When it comes to forex trading, it is important to understand these fundamental aspects of the market and they can lead to a better understanding of the system and better decision making.