Money (Part III) - Money in the international market

Local and Foreign Currency

It’s a pretty obvious understanding but nevertheless I’ll go ahead with the definitions of them. Local Currency is the notes and coins that are used by a country within its geographical boundaries. Every country has its own local currency. It might be internationally used but still it’s their local currency as well. So Foreign Currency is naturally any other currency (note or coin) that is being used by other countries.

So when it comes to the International trade how does this work out? Two different currencies may have two different values altogether. For an example, $1 will most likely not equal the value of GBP1 or 1 Euro. Although the face value is 1, the real value, i.e. the good and services that can be bought with this 1 dollar, Great Britain pound or the euro will not be the same. To overcome this, economists have come up with the term ‘Exchange Rate’.  

Exchange Rate

Exchange Rate is the rate at which one currency unit of one country is exchanged with another currency unit of another country.

For an example as of today (19-02-2012) 1 US Dollar = o.759 Euros

                                                                      1 US Dollar = 0.631 Pounds

                                                                      1 Euro = 0.83 Pounds

Almost all the country’s currencies can be converted as above.

The practical application of the exchange rate is as thus. In the above figures, 1 US Dollar equals 0.759 Euros. This means that any good that costs 1 dollar in the United States will only cost 0.759 Euros in the European region. So we can roughly come to a conclusion that goods in the European region are cheaper than that of the US, hence they cost less.

There are two types of Exchange Rates mainly.

1) Fixed Exchange rate – the exchange rate of the domestic currency is fixed with another country. It’s not allowed to fluctuate. This is done by the Central Bank of a country on behalf of the Government. Fixed exchange rates could have many advantages, the most prominent being predictability. Importers and exporters are aware of the exchange rate and can be pretty sure about the future rate as well. This will help avoid unexpected losses due to exchange rate fluctuations.

2) Floating Exchange rate – here the exchange rate is allowed to float at will. Not at will exactly, but it will float mainly based on demand and supply factors and a million other small factors. An increased demand for the local currency will improve its value and thus decrease the exchange rate and vice versa. However from time to time the Central Bank will influence this rate to get things back in favour. This is known as ‘Managed Floating rate’.   

Foreign Direct Investments (FDI)

These are capital investments made by one country in projects of other countries. Here the exchange rate is widely used since fluctuations in the exchange rate could affect the value of the investments.

International Monetary Fund (IMF)

IMF is an international organization striving to achieve global monetary cooperation, secure financial stability, sustainable economic growth and reduce poverty around the world. (Source : http://www.imf.org/external/about.htm) It grants funds to poor countries to complete various projects. For more info visit : http://www.imf.org/external/index.htm

IMF headquarters is located in Washington DC, USA.

World Bank

World Bank is another international regulator, who provides funds, grants, loans and various subsidies for developing countries.

For more info visit : http://www.worldbank.org/

The headquarters are located in Washington DC, USA.

From the next article we hope to bring you all about the black money and how an economy responds to black money.

Thanks for reading.

Good Luck - NJK Stock Market Guide

Money (Part II) - Where does it come from?

Where does money come from?

Money, so important to us, does not just appear. It is made like any other product. The government and the Central Bank of a certain country are the authorities held responsible for printing and issuing money to the general public. There are specialized companies to print and mint money. (Eg: Thomas De La Rue) We may think that these companies are so rich since they print money, but the truth is they cannot print money at will. They can only print money when a government places an order to print money, just like producing a normal good upon customer order. Unlike normal businesses, money printing companies cannot keep stocks, obviously, they will mostly operate once and order is placed.

Money Supply

Money Supply (AKA monetary base, base money, money base, reserve money)  is the total money in circulation in an economy at a given point of time. Simply, how much money is within the economy at a certain point of time? Money Supply is a key variable within an economy. It affects the economy and all its activities to a great extent. Money supply affects the price levels, interest rates, investments, production, consumption etc. So how is this money supply measured? It can be measured in 4 ways.

1    1)      M1 – Narrow Money Supply

Narrow Money includes all the cash in hand of the general public and all the demand deposits of the public held in commercial banks.

2    2)     M2 – Broad Money Supply

M2 consists of M1 plus all the Savings deposits of the public held in commercial banks

3    3)     M2b – Consolidated Broad Money Supply

M2b consists of M2 plus all foreign currency deposits of the public in the commercial banks.

4    4)     M4 – Very Broad Money Supply

This consists of m2b plus all the savings and fixed deposits of the public held in financial institutions other than commercial banks.

So that’s a lot of money within an economy and has to be managed effectively. The sole authorities responsible for managing and controlling the money supply in an economy are the government and the Central Bank of the specific country. However the Central bank only engages in the process on behalf of the government.

The main method of influencing the money supply in an economy is through the Repo and Reverse Repo market. These are the two markets that the central bank uses to issue and purchase treasury bills and treasury bonds of the government. (Treasury Bills are short term debt instruments issued by the government to settle their short term cash deficits)

In the Repo market the central bank will issue T. Bill to the general public and people/commercial banks will buy these bills spending the cash balances they have, thus decreasing the money in circulation within the economy. Remember, the above categorization of money supply did not include anything about money held by the government or the central bank. So when the central bank absorbs the cash in the economy it’s like gone or lost.

On the other hand in the Reverse Repo market, the central bank will buy back the T. Bills they issued earlier, of-course at a higher price than what they were sold for. So the person who bought the T. Bill has a capital gain plus an interest component associated with the bill. So when the central bank buys back the bills, it will release the money held with them to the economy thus increasing the money supply.

Intrinsic Value and Extrinsic Value of money

Money basically has two values. Yes! The value mentioned on the face of the note or the coin is known as the extrinsic value of money. It’s the value assigned to the specific note or coin. For example the extrinsic value of a $100 note is simply hundred dollars. And the note can be used to do transactions up to a $100. However, this note is printed on a paper, yeah some special paper, but still a paper. This piece of paper definitely does not worth $100. The real value of the note (paper) is known as the intrinsic value. It might be eve less than $0.50 for the $100 bill.

Features of ‘Good Money’

= General acceptability – money should be accepted by everyone as a medium of exchange

= Scarcity – should be difficult to find and obtain

= Durability – should be durable due to heavy usage

= Divisibility – can be divided in to smaller units (Eg: dollar can be exchanged to two 50 cent coins)

= Portability – should be easy to carry around…

In the next part we will discuss about how money functions in the international market.

Thank You for reading.

Good Luck – NJK Stock Market Guide

Money (Part I) - History and Evolution

Money

We use it every day, we cannot spend a day without it, we touch it, we feel it, we spend it, and we earn it. Yes, it’s money. It has become almost impossible to live without money. Don’t agree? Well, continue reading.

We wake up in the morning, from our bed, let’s assume $150. Turn off the alarm in the clock, which is, say $20. We go to the bathroom, wash ourselves up, we may not notice at the instance but the water bill is getting accumulated everytime you turn on the tap, shower etc. Then you get dressed up, $20 shirt and $20 trousers, pair of shoes $30 and all other what-not’s. Then you leave the house, get into a bus, pay $2 or something and get to your work. Before going in you decide buy a burgher from a stand, $2. I could go on and on like this. The point to be taken is that, money is so close to us, it’s so engraved into our lifestyle, it’s so significant and delicate.

So let us now take a little tour into the world of Money. Starting from the history and expanding to the future of money and most importantly, how to have enough of money forever. Take a deep breath and read on.  

What is Money?

First up, before heading into the history it’s better have a general idea what money is. If I ask you what money is, you’d probably say $1 note, $100 note, penny coins etc. Well, that’s only a part of the story. Because by definition money is “anything that can be used as a medium of exchange”. Wait, what? In simple it says, money can be anything, it does not necessarily be notes and coins that we use today. It can be anything as long as it is accepted as a medium of exchange. “Medium of exchange” means something that can be exchanged with another. Hence the medium should be accepted by all the parties involved in the transaction.

Let’s say for an example that I need to buy a new TV which costs $1000 and let’s assume that I have only $600 in cash with me. If the TV vendor agrees I can pay the balance $400 with something else, say some piece of jewelry I have. So in this case, the jewelry too is accepted as money since it aided in completing a transaction.

Likewise money isn’t only the notes and coins we use today. This will be further illustrated in discussing the history and evolution of money in the coming paragraphs.

History and Evolution of Money

The history of money dates so far into the history to the times when ancestors used little pebbles to buy things from others. Yes! That happened. But exchange of goods and services started even prior to that in an era named ‘The Barter System’.

The Barter System

The Barter System means a system where commodities were exchanged for commodities. In simple goods were exchanged for goods. There was no ‘money’ involved here. People exchanged their excess production with someone else’s excess. The system had many failures such as;

•    No double coincidence of wants - this means that not always did everyone’s wants match. Someone would have excess rice and want some eggs. But the one who has eggs may not want rice. So the coincidence of wants between parties was not always there and this hindered transactions largely.
•       No specific unit of value - it was hard to define a value to each product.
•      No specific measure of value – there was no way of determining what the exchange rate should be. i.e. how much rice should be exchanged for a bag of rice.
•       Difficulties in transporting goods – goods had to be carried around the villages and even to other villages to be exchanged.
•        Perishable good like food items could not be stored for long.

Due to such drawbacks people soon realized that exchanging goods for goods wasn’t a very effective system.

Then came the use of medium of exchanges for transactions. As I’ve mentioned above, this could be anything.

Commodity Money

This is the second era of the evolution of money, when people shifted from the Barter system to the use of a medium of exchange instead of goods.

In this stage people started using small stones, pebbles from the seashore, rare feathers, tobacco etc for transactions. These are the earliest stages of money. These items had assigned values, but often were not very decisive on their values. At first these items were rare to be found but later on people found more and more pebbles at the seashores, more feathers from birds, they started growing tobacco, and so the value of these commodities as money ceased. They needed something more consistent and limited in supply.

Paper Money

This is the third stage of evolution of money and the earliest stage of the money known to us today.

In early societies goldsmiths were the wealthiest people in the village. When people wanted to buy something, they would take something of value to the goldsmith (not necessarily, someone of wealth would also be sufficient) and keep the goods with the goldsmith and take a note from him signed to the value that he has kept with the goldsmith. Then this paper was valid to do any transaction up to its value mentioned. With time this system too came to pass.

Notes and Coins

The first notes and coins that we use today were printed In England by Stockholms Banco in 1661. Since then these notes and coins have evolved in different material, shapes, sizes and values.

Modern coins are minted in silver, copper, nickel etc. And money notes are made out of special paper that withstands heavy use, wear and tear.

E-Money / E-Cash

This is the modern plus future of money. Money in the electronic form. Even today with or without our knowledge we use E-money for online purchases, online payments, credit settlements etc.

Paypal, Alertpay, Moneybookers are a few examples of the institutions that facilitate online payments. Besides these specialized institutions, almost all commercial banks provide online payment facilities nowadays.

These are the four eras of development of money to the present stage. This is a very brief introduction to the four stages. But I hope you gained some knowledge. This is merely the beginning og the journey with the money. Await the next part to know about, where does money come from? Who supplies and controls money? and many more.

Thank You for reading.

Good Luck - NJKStockMarket Guide