![]() ![]() Bitcoin for example, the cryptocurrency so often in the news, is a fundamentally deflationary currency. This suggests that if governments want to maintain a stable currency, the money supply should be increased in line with economic growth, plus a little extra for money that is lost or destroyed. If the creator of the dollar, which in the real world is the central bank, created a second dollar, doubling the money supply, two dollars would be equal to two cars and the original valuation of the dollar would be restored.Īlthough modern day economies have millions of different goods and services and Trillions of dollars in circulation, the fundamental principles should still apply. If the car owner wants to sell both he will quickly come to realize that one car can only be sold for, and must therefore be worth, 0.5 USDs. Or conversely, that the dollar in the economy has appreciated and can now purchase two cars! This phenomenon is called currency deflation, which is also effectively “car inflation”. Now imagine that the owner of the car makes a second one. But there is still only one dollar in the economy. The value of money in circulation is proportional to the wealth in the economy (there are a number of complicated effects, which aren’t the topic of this paper, that mean it won’t be equal). The same principle can be extended to modern economies. If the car is bought for less, the remaining money is useless and can be discarded. After lengthy negotiations, the two parties come to realize that the value of the car must equal the value of the dollar. If the buyer purchases the car for less than one USD, the remaining cents he will have left will be useless, since there is nothing left in the whole economy to buy with them. The seller will realize that he can’t possibly sell his car if he charges more than the value of the USDs in the economy, and therefore could only ever charge a maximum of 1 USD. The owner of the car wants to sell, wants the highest possible price, and is the only seller. The owner of the USD wants to buy the car, wants the lowest possible price, and is the only buyer. Imagine an economy with only one USD and only one car. ![]() So, what are the underlying drivers of Supply and Demand? Modern currency markets are extremely complex. But their complexities are not necessary to understand the fundamental underlying drivers behind currency valuation. Equilibrium will be reached when, at a given price, buying and selling are occurring at equal rates. Given a fixed supply of GBPs, and an increasing demand for GBPs, the value of one GBP will increase as buyers outbid each other. As with all goods and services, market valuation is a question of supply and demand. ![]() Effectively, making a penny worth more than a penny. Indeed, there have been times when the copper of British coins has been worth more than the purchasing power of the coins themselves. Or arguably, it’s worth the value of a small piece of paper or amount of metal. But this doesn’t help answer the real question: Should 1 GBP be worth 2 USDs? Should it be worth more? Should it be worth less?Ī dollar in itself, isn’t worth anything. If the GBP/USD market exchange rate is 1-to-2, one pound is worth two dollars. Fundamentally, currencies are worth what someone is prepared to pay for them.
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