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Money has a long history, and today each country usually has its own currency. This means that if you travel or do business around the world, you need to trade one currency for another. At first this seems complicated, and many people wonder: Why can’t we all use the same money? In fact, there are good reasons why each country keeps its own currency. Most countries have unique economies and goals, so they want to control their money in the way that best fits their needs . We will explain how money evolved, why separate currencies exist, and how currencies are exchanged when people cross borders or buy goods from abroad.
History of Money
Long ago, paper money and coins did not exist. Everyone simply exchanged by bartering, that is, by the exchange of commodities. So, the farmer would exchange his basket full of grains for shoes by the shoemaker. But trade was limited: you had to identify someone who desired exactly the thing you possessed and possessed exactly the thing you desired. To facilitate exchange, humans steadily began using some things as money. Initially, goods such as shells, cattle, salt, or metal tools were exchanged.These were things that most people believed to be worthwhile so they could present them for other goods with relative ease.Governments and leaders over the course of centuries also simplified the use of money. In the year 600 BC, the ancient kingdom of Lydia (modern Turkey) began producing the world’s first official coins made of silver or gold.
The coins also had pictures on them and had certain values. This allowed people to carry money instead of heavy loads, opening the way for faster business and trade. In the 13th century the Paper money was issued later by China. At first, paper money was just a bank’s promise to give silver or gold in return. However, over the years, most countries switched totally to paper or electronic money.
Most nation states by the 19th and 20th centuries had central banks that generated their currencies. Many for centuries used the gold standard, where the paper money was exchangeable for an established quantity of gold. In the mid 20th century, after World War II, the main countries started the Bretton Woods system. And in this process, more currencies were connected to the U.S(United states) dollar, and the U.S. dollar was linked to the gold. Finally the system ended in the early 1970s. Since then, every country has issued its own money, and the value of these currencies goes up and down compared to each other.
Reasons for Different Currencies
The main reason is that they want to control their money. Every country has its own economy, people, businesses, governments, and laws. To fit their economy, leaders like central banks or the government want to control the interest rate, inflation rate, and money supply. If the entire globe had just one currency, then the entire globe would have just one central bank overseeing that currency on behalf of all the countries. That would not be very good for the countries that are emerging very quickly and the countries that emerge more slowly. In June 2016, the United Kingdom voted for the country to withdraw from European Union (Brexiting). Following the exit vote, the British pound immediately depreciated which reflects the level of uncertainty amongst investors in the United Kingdom economy. However, the United Kingdom was not constrained by its own money supply and so it was able to change its monetary policy in the face of uncertainty. If the United Kingdom were on the euro instead of the British pound, it would have been constrained by the common currency and could not have made the choice.
Using their own currency gives a nation sovereignty through their central bank. The bank has options to create or withdraw money, alter interest rates, or realistically address macroeconomic issues, such as inflation or unemployment. A strong, stable currency would allow us to travel abroad less expensively while limiting the expense of imports. Conversely, a weak currency could stimulate more export sales because the products seem less expensive to foreigners. For instance, Japan typically prefers to have a weak yen because Japanese cars and electronics become cheaper for foreign consumers to purchase, therefore benefiting their manufacturer. When people are living in a country with a weaker currency, there is purchasing parity with foreign products.
Currency is also an important part of identity and pride when people see the familiar faces of leaders, heroes, or symbols on coins and currency notes. Currency names such as “dollar,” “pound,” “euro,” “rupee,” or “yen” are all, to some extent, based in history or tradition. Some countries also maintain currency as a political statement. For instance, the UK opted out of using the euro in order to retain full sovereignty over its money, interest rates, and inflation rather than sharing control over these variables with other countries in the European countries.
But there are also risks to sovereignty. It is possible for a government to print so much money that it causes its value to go down or create inflation. In some cases, this inflation can turn into hyperinflation. Between 2008 and 2009, Zimbabwe printed so much money to pay for its debts that prices increased over 100 billion percent! At one point, people could buy only a few eggs for a single 100-billion-dollar note. People lost their trust in Zimbabwe’s money, and it finally dropped the currency. Today, Zimbabwe uses US dollars and currencies from other nations quickly because its own nearly became worthless.
Example of hyperinflation: In 2008, Zimbabwe’s money lost so much value that one egg cost 35 billion Zimbabwe dollars. A vendor once used a 100-billion dollar note only to buy a few eggs..
Currency unions are rare because it is difficult to manage a common currency for different economies. The only real example is the euro. At present 19 European countries share the euro, with over 340 million residents using the euro on a daily basis, which has made life easier for travel, shopping, and commerce by removing one more currency to exchange and by providing more price transparency.
The trade-off is that eurozone members gave up their own currencies. The European Central Bank sets interest rates and manages how many euros are in circulation for all the eurozone countries. This means that an individual country cannot print euros nor have some control over interest rates during times of a crisis. Greece couldn’t just devalue its currency in 2010 when it was in crisis because it couldn’t go back to drachma. Greece had to accept eurozone terms and would need to be completely dependent on aid to get out of the crisis. As the eurozone situation demonstrates, having a shared currency among member economies does not work if they are not all facing the same direction. That is also why British citizens chose to remain outside of the euro and keep their own currency.
The majority of the world’s countries still use national currency. But in certain smaller or weaker economies, they may choose to adopt other countries’ money, typically the US dollar or the euro, instead of printing their own currency.This is called dollarization (or euroization). Take Ecuador and El Salvador as recent examples of countries that both officially adopted the US dollar. Or consider Panama, which has its own currency, the balboa, but is tied to the US dollar at 1 to 1, and US dollars are freely used there. The benefit of dollarization for those countries is stability with their money and preferred lower inflation rates. The downside is that they do not control the money supply—they do not clip U.S. dollars, so national policies depend on the U.S. Federal Reserve.
In the end, this is all part of the reason why the world has different types of currencies. Some countries give up their own currency for stability, but, for most, they keep their currency to have control.
How currency exchange works
When countries offer a different currency, people and businesses will have to exchange money to trade, travel, or invest. A currency exchange rate specifies the value of a currency versus another. For example, if the exchange rate is USD-CAD (U.S. dollar to Canadian dollar) market bid/ask 1.3426 – 1.3432, you can convert $100 U.S. to 134.26 Canadian. We can also simply say, at that exchange rate “100 USD = 134.26 CAD.” In general, rates are shown for 1 unit of the base currency (here USD), meaning you multiply by the rate to see how much you would get of the other currency.
Exchange rates can be floating or fixed. Exchange rates that are floating have their value determined by trading in the foreign exchange market (Forex). Forex is an enormous network of banks, companies, investors, governments, and traders throughout the world wide that buy and sell currencies. This market trades 24 hours a day. The value of a currency rises when demand for that currency is higher than the supply and falls when supply of that currency is high or demand is low. For example, if a lot of people want euros (maybe Europe’s economy is strong and investors are undertaking investment using euros), the euro will rise in value against other currencies. In contrast, if a country’s economy looks risky or their inflation rate is very high, that currency might weaken as people sell it.
Example of a currency exchange: The image shows euro banknotes exchanged from one person to another. If you needed euros instead of US dollars, then you would exchange them at the existing exchange rate.For example, at the exchange rate of 1 USD = 0.85 EUR, $100 will give you €85.
When countries use a fixed exchange rate system, a government or central bank announces a commitment to maintain its currency at a particular value compared to another currency (or currencies). To do this, the monetary authority will be active in the forex market, which may involve buying and selling its own currency or will use interest rates to manage value. Several countries in both the Caribbean and the Middle East have simply pegged their currencies to the US dollar to eliminate price distortions. For example, like the Saudi riyal, it is pegged to the dollar at around 3.75 riyals per dollar. This explains the high level of comfort for businesses when it comes to making trade or investment activity because it means the currency will not suddenly jump around. Conversely, when using a fixed system, the central bank forgoes its options and must actively manage its money supply in order to defend its currency with respect to the peg rather than for domestic considerations.
When you exchange funds in person (like at the airport, bank, or currency exchange booth) you will see two prices for every currency, a buy price and a sell price. The buy price is what the dealer pays if they buy your funds, the sell price is what the dealer charges you when they sell the funds. The difference in these two prices is called the spread and it covers the dealer’s costs. For example, airport exchange booths do often have worse rates than local banks, so many tourists and travelers like to compare places to find the best rate. Another option is withdrawing cash from an ATM while you are out of the country. Usually, ATMs provide a rate close to the official market rate although your bank may adding a fee.
Today nearly all of the money exchange is done online. Banks and companies trade billions of dollars worth of currencies every day for business, trade, or investment. Regular people do this without even thinking about it when, for example, they use their credit card while visiting another country or send money overseas—even if they do not know they are exchanging currencies your bank is doing discrete currency exchange for you.
You can check live exchange rates on websites or applications as well. Even on these platforms rates are never static, they are constantly changing based on the market.
Trade balance: If a country exports more than it imports (buying) it will increase the value of their currency.
Interest rates: Higher rates increase the probability to attract international investors, therefore lead to a stronger currency.
Inflation: High inflation weakens currency, low inflation maintains a strong currency.
Political stability: Countries that are safe and stable attract a lot of money. Unstable political environments will cause investors to take their money out (e.g. Brexit caused a drop in the value of the pound).
Speculation: Traders who buy and sell currencies can move the value up or down.
Exchange rates move all the time, where big companies can often fix the rate to minimise risk, but ordinary tourists accept the daily changes.
Examples of Currency Exchange
Let’s say that you live in the U.S. and you decide to go to London. You have a dollar amount to exchange, and you want to exchange it for the same dollar amount in British pounds. If the conversion rate is 1 USD = 0.80 British pounds, to have £500, you need to pay 625 US dollars. You walk into the exchange place and notice banks have a bid price and ask the price for exchanging the currency (“USD/GBP = 1.250 / 1.275”). In this instance, when you buy(give your USD), you will pay 1.275 and when you sell (get back GBP) you will receive a price of 1.250.
The same conversion process happens with bigger companies, and a company in the US that is buying vehicles from Japan is exchanging dollars for yen. If the exchange rate is 1 dollar = 110 yen, the car that lists for 11,000 yen will cost the company $100 to purchase. If the exchange rate has changed and is now 1 USD = 100 yen, it will cost the company $110 to buy the same car. This is the exchange risk which sometimes makes companies want to hedge.
Digital tools provide an easy path for a variety of exchanges today. Payment apps and multi-currency cards often quote rates that are close to the market.
The basic rule remains the same: more demand makes a currency stronger, more supply makes it weaker. When foreign investors invest in a country, its currency goes up. When they pull that investment out, the currency retraces.
Currency Codes and Symbols
Every currency has a name/sign/symbol/mark and an international code. For example: US dollar ($, USD), euro (€ , EUR), yen (¥, JPY), pound (£, GBP). All currencies are identified through standards set by ISO 4217, which help to eliminate ambiguity in currency exchange globally. For example, if you see “USD – EUR = 0.92,” simply means that 1 US dollar equals 0.92 euros. These codes help to provide clarity in avoiding confusion, such as when a cashier in Paris looks at a receipt and sees “100 USD” where they may have to convert to euros, and simply looks at the euro/british pounds table to get a rate.
Conclusion
Countries use different currencies because they need their own monetary policies. Separate currency allows the government to manage inflation, interest rates, and money supply for their own purposes. While there are some relationships in currency like the Euro Zone, most countries prefer to issue their own currency for flexibility. Currency exchange takes place in global markets, banks, and shops, where the “value” of a currency is always changing based upon supply and demand. Travelers, businesses, and investors trade currencies based on the real-time value, that includes a small fee. As long as countries are separate independent nations, a world of currencies will remain, and understanding how the world’s currency exchanges work helps us understand trade, travel, and global news.
Authored By: C. Sayeed Pasha from Andhra Pradesh is a final-year student of Qur’an and Related Sciences at Darul Huda Islamic University, Kerala,
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