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06 Currencies

As an exchange rate changes some trade rings break and localise and others connect and globalise. One issue is the completion of trade chains and the probabilities of doing so in larger and smaller economies. Clearly stable exchange rates are better for the real economy but worse for the speculators.


Cost of Currency

The interest rate demanded might be considered the cost of currency.

Price of a Currency

Determined by the offers for sale and bids to buy in the currency now and potentially in the future.

Breadth of a Currency

How broad is the currency? The ratio of narrow money to broad money in the economy. Clearly this ratio is limited by the reserve ratio and capital adequacy requirements. It gives a clear indication how much money is borrowed, rather than earned and lent rather than spent. Savings are another matter but normally we save in a bank account which actually means we are lending. There is very little genuine saving in most currencies, i.e. mattress money!

Clearly lenders hope to get interest and banks are instrumental in achieving it i.e. subordinating the borrower to the lender.  While the subordination in the economy is stable then it will continue however however it is limited by what people can pay in interest.

Risk in Subordination

Debt of course has a risk of default so in the broader currencies one must examine the risk of default. If the debt is asset backed then the asset can be taken, however where that asset has bubbled the debt may no longer be recoverable, and such bubbles are to be expected where banks over lend for the purchase of particular types of thing such as houses.

The ability of banks to sell on debt with unclear risks attached to it has lead to toxic debt or junk debt i.e. debt that pays low interest but is high risk.

Non-Central Banking

Clearly the success of banking depends on debt and so they will potentially attempt to promote debt to the maximum extent only limited by the risk of default.

Central Bank

Many central banks have board members who are from other banks and so will understand and promote the interests of the non-central banks, maintaining interest rates at a level so as to maximise bank interest returns over the long term by attempting to stabilise the economy and avoid defaults.

Central banks have bought bad debts to relieve other banks of the risks and much of this new money has served simply to recapitalise the banks in the face of higher capitalisation requirements and to counteract losses of capital on asset backed loans.

International Debt

There is of course national debtors and creditors bodies that reside within the domains of nations. Governments and central banks are just such bodies.

The added complexity is that a nation may hold many currencies but its central bank may only control one. i.e. set an interest rate and reserve rate for one, and thus determine the amount of money and breadth (debt) of that currency.

Inter-Economy Trade

As has been said an economy is the economic domain defined by the fact that all monetary transactions within it use a given currency and all monetary transactions outside it use some other currencies. Usually this corresponds pretty well to a nation as most nations have their own currency.

What normally happens if two economies trade with each other is a foreign currency market appears where the currencies are traded, this is called the FOReign EXchange market or FOREX market. Thus the price for buying one currency with another (the exchange rate) is determined by the bids and offers on this market and those will be effected by what can be bought with, or sold for, each currency, or so it should be. But because the majority of currency traded is speculative the actual prices are subjected to fluctuations based on the beliefs of the speculators rather then what can be bought with, or sold for, each currency.

Subpages (1): FOREX