Measuring the value and usefulness of a currency

[KrazyHorse]

You are missing the point--the most baffling thing to me is that the 2 dollar bill is the SAME nominal value as two one dollar bills, yet you would rather have two 1 dollar bills than one 2 dollar bill because it's easier to use. The difference in utility is NOT reflected in the value of the currency because the value of a currency is, as far as I can tell, not or very loosely related to its actual utility, except perhaps in the exchange rate example I mentioned where you trade in and trade back and see what you lose.

xpost

This shouldn't be baffling to you; this is the idea of liquidity; that on demand you can translate the asset into some other asset with minimal transaction costs

For example, a barrel of oil might go for 80$ today (well, generally in the nearby futures contract), but I'd rather have 80$ than a barrel of oil because of the transactions costs of turning a barrel of oil into an 80$ MP3 player

However, I doubt this is really the purpose of the assignment you've been given. More to follow.

[KrazyHorse]

KrazyHorse--I am actually specifically hoping for your answer to this question, if you have one, I see you've been viewing the thread for a while . I haven't found anything on the internet so far about this, but I kind of doubt this is a new idea. Perhaps it is a hard question?

HC, I am at work between the hours of 8am and 8pm. When I am at work, I browse and post on Poly using my phone. I saw this thread earlier, and it's actually a quite interesting topic, but I'm not going to spend my time trying to type an essay into a phone's touchscreen.

On the other hand, I am 4 martinis deep right now, so take my answers with a grain of salt

[KrazyHorse]

Oh jeez... I'm actually the guy who, as I said, took courses in International Monetary Econ from an accredited institution and KH is the brilliant one because he's read a few books


I don't get why you are asking these questions and why they perplex you. As far as I can tell, you're saying that whatever the exchange rate is between the pound and the dollar, you get additional utility by possessing pounds instead of dollars in England and dollars instead of pounds in the US beyond the straight exchange rate. You want to know how this is measured and how it is taken into account. Is that what you are asking?


Oh and if you keep converting currency, all you lose is the spread

Hi, ****.

It turns out that currency is both the unit of account and the means of exchange. As the means of exchange for relatively small purchases there is an enormous cost in having something other than the prevailing currency.

By the way, congratulations on having taken International Monetary Economics. Too bad you didn't learn anything

[KrazyHorse]

In order to determine the value of "joining the euro" for a given country, let's look at the significant effects it would have on a given country. From LEAST to MOST important for marginal Euro countries (think Turkey or Greece; let's call it Kreplakistan, which previously had the Kreplakistani Lira, symbol KRL), here are the issues:

1) Currency is the unit of exchange and the unit of account. By creating a unified currency, you eliminate the costs of engaging in hedged transactions with Kreplakistani businesses. In effect, you are reducing the cost of entering a currency forward in the broker/dealer market from 10 bps to 0 bps and the cost to retail transactions from 200 bps to 0 bps. This is vaguely important, but not critical

2) You have imparted greater credibility to the currency. Because Kreplakistan no longer controls the printing presses, the fear that the Kreplakistani government may engage in hyperinflation of the KRL is eliminated. The cost of government debt will come down (the government no longer has the option of a soft default whereby they inflate away their obligations; it will have to officially refuse payments to creditors instead. Because of the common currency it will commit macroeconomic original sin (issue debt in a currency other than its own). In a crisis, the effect of a gradual devaluation rather than an actual default may be smaller.

3) It will cede monetary policy to the Euro central bank. Because it no longer controls the printing presses, Kreplakistan can no longer meaningfully affect inflation rates (or any other nominal value) through direct action. If Kreplakistan has significant idiosyncratic economic factors, then it will suffer dislocations as domestic inflation changes relative to the currency area.


In general, countries who want to go on the Euro would be those which are relatively small (markets in their currencies are less liquid, leading to large transaction costs to hedge currency risks) and have significant trade ties with the host area (the currency hedging risks are a significant fraction of total costs of trade with between the host area and themselves), relatively badly-run (there is fear that their government will cause large inflation swings if it controls its own currency) and relatively homogeneous with the rest of Europe (the lack of an independent monetary policy isn't much of a concern).

The study of this question is generally termed the study of "optimal currency areas". There are any number of considerations, but as far as I can see, these are the three major themes.

[KrazyHorse]

double post

[Dinner]

A currency's value to me is determined by what I can buy with it compared to what I can buy using other currencies. Yes, that's nominal value but that's all I really care about and the rest is academic.

[Al B. Sure!]

What the **** is so funny. That is correct. I remember that much clearly.

[MikeH]

Going back to the OP. If it says "joining the Eurozone", you might want to look at the economic changes due to opening up labour markets and entering the free trade zone as well, as it'll include joining the EU. Unless it means specifically means existing EU members entering the Eurozone.

[KrazyHorse]

What the **** is so funny. That is correct. I remember that much clearly.

What's so funny is that you don't understand that a common currency makes the claim you made retarded...

[Al B. Sure!]

What's so funny is that you don't understand that a common currency makes the claim you made retarded...

What is so absurd about the idea that the EU member states do not have sovereign control over monetary policy because they are constrained by the EU to insure that common currency has the same value throughout the Eurozone? How do you think it works, genius?

[MikeH]

I think it's this bit that he's laughing at:

to ensure that the Euro remains the same value in each country.

[Al B. Sure!]

I think it's this bit that he's laughing at:

Well yeah. Can you imagine what would happen if German interest rates were considerably higher than French or if Italy had inflationary monetary policy? The value of the Euro would easily diverge between member states if they had full control over their own monetary policy.

Impossible Trinity stuff.

[KrazyHorse]

What is so absurd about the idea that the EU member states do not have sovereign control over monetary policy because they are constrained by the EU to insure that common currency has the same value throughout the Eurozone? How do you think it works, genius?

, you ****ing idiot. You still don't understand your mistakes?

[Al B. Sure!]

, you ****ing idiot. You still don't understand your mistakes?

Well if you want to act like pegged/shared currency, free capital flow, and independent monetary policy can all work together, then whatever. EU member states do not have full sovereignty over their monetary policy. If they did, one of the other two would have to give.

[Hauldren Collider]

This shouldn't be baffling to you; this is the idea of liquidity; that on demand you can translate the asset into some other asset with minimal transaction costs

For example, a barrel of oil might go for 80$ today (well, generally in the nearby futures contract), but I'd rather have 80$ than a barrel of oil because of the transactions costs of turning a barrel of oil into an 80$ MP3 player

However, I doubt this is really the purpose of the assignment you've been given. More to follow.

It's not really related to my assignment, it's just something I was wondering about. I'm guessing the measure of liquidity is the transaction cost, which is (as I understand) basically the same as a bid-ask spread.

HC, I am at work between the hours of 8am and 8pm. When I am at work, I browse and post on Poly using my phone. I saw this thread earlier, and it's actually a quite interesting topic, but I'm not going to spend my time trying to type an essay into a phone's touchscreen.

Alright, I'm not trying to be pushy, sorry. I appreciate your answers though--thank you.