A Beginner’s Guide To Currency Valuation

The market value of asset is largely a reflection of supply and demand for that asset. And thus, if we are looking to assess the value of a currency, we should try to gauge the supply of and demand for that particular currency.

Understanding Supply

To understand money supply, it is crucial to note that in under current monetary policy, money is created out of debt. This happens in two ways:

1. Money is created when governments need to borrow, and central banks then print money and sell treasury bonds
2. The money supply is then expanded again when banks loan money; banks are allowed to loan out 10X the money they have in deposits, and thus expand the money supply when they loan.

Because money comes out of debt, we can extrapolate two further points:

1. If there is no more debt — meaning if lenders are not willing to lend and borrowers are not willing to take on more debt — the money supply will have difficulty expanding.
2. Paying off debts results in decreasing the money supply. Ironically, if all debts were repaid, there would be no money.

The Mises Institute also offers a free tool to let you compare various money supply indicators.

Understanding Demand

The following can help you gauge demand for a currency:

Trade flows — is the country in question a net importer or exporter?
Capital flows — is investment capital coming or going?
Reserve currency status — do other central banks hold the currency in question as part of their reserves? Are they changing their reserves?
Commodity prices — If commodity prices are rising, the currency is likely weakening

Gauging how supply and demand is changing can help you develop a longer-term outlook on how currency prices will fare.

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Comment by Jason

2008-12-09 20:13:31

Pumping up the money supply should melt a credit freeze. The Fed chairman faces huge obstacles
in trying to restart the credit engine and get maxed out consumers spending again. Given the
scale of the Fed’s interventions, it should be weakening the value of the dollar and setting
us on a course toward inflation. Inflation happens when prices rise. Deflation happens when
they fall. In this December’s dark economy, falling prices for gasoline, cars, and clothes and
just about anything would seem like a silver lining.

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