6 Oct 2022

What makes a dollar? Determining the value of a currency

From The Detail, 5:00 am on 6 October 2022

In late September, the New Zealand dollar dropped to its lowest point against the US dollar in 13 years. Bad news if you're about to holiday overseas but good news if you're an exporter. Currency traders make money out movements in the market but what drives our dollar up and then down? 

New Zealand currency held fanned out in someones hand

Photo: 123RF

Learn the value of a dollar, your grandmother might've told you.

But one thing she may have failed to consider is that the value of a dollar fluctuates. A lot. Month-to-month, day-to-day, minute-to-minute.

Back on September 26, one New Zealand dollar would've bought you 54 British pence.

Just a week later, that same dollar would've bought you just 50 pence, and that might not sound like much, but it's an eight percent difference.

So why? Why do currencies change value all the time? What are the factors that determine whether a currency is strong or weak? What are the benefits and drawbacks to having a strong currency? Why did the British pound plummet in late September, and why is the US dollar so strong at the moment?

The Detail talks to RNZ business editor Gyles Beckford and ASB economist Chris Tennent-Brown about the many, varied factors that dictate the value of a dollar.

"Currencies, in the broadest sense, [are] stores of value," says Beckford.

"They tell us that the note, or the coins, or the swipe of the Eftpos card will buy you so much.

"In millenniums gone past it was shells, it was bits of wood, stones, ceramics.

"But we've seen it right through ancient history: here is something, it's a means of exchange, and you and I can do business in buying and selling goods and services with that currency."

But what factors go into how a currency is valued? ASB senior economist Tennent-Brown explains it's economics 101.

"At a very simple level, supply and demand: if we're talking about what a New Zealand dollar is worth relative to a US dollar, thousands of people meet in the market, wanting to buy and sell currencies for all the various reasons they do, be it trade, travel, speculation, investment, and there's a meeting point where you can determine the price of one dollar versus another, and that's what happens every single day."

Many currencies have experienced market turbulence over the past year or so: the Japanese yen hit its lowest rate in more than two decades; earlier this month, the Korean won declined to its lowest level in 13 years; and just over a week ago, the British pound plummeted against the US dollar, following the announcement of sweeping, un-costed tax cuts which have since been reversed.

But Beckford says these trends don't reflect unique weakness in these currencies, but unique strength in the US currency, the greenback, which he describes as the "de facto global currency".

This has been prompted, Beckford says, by instability in other parts of the world: the US, the world's biggest economy, is seen by investors as safe haven in times of uncertainty in major economies.

In terms of the New Zealand dollar, Beckford says there is a balance to be struck: broadly, exporters like Fonterra are happy when the dollar is slightly weaker, while importers like the dollar to be strong, as they get more bang for their buck when purchasing products from overseas markets.

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