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Fundamental Economics: The value of a currency

For the past several months, the Philippine currency (peso) has been increasing in value against the US Dollar. A year ago, the peso was at 55.977 (3 Oct 2005). It fluctuated several times but the trend was a continuous climb. Today, the Peso seems to be standing on solid ground, as it refuses to yield beyond 50.

How does one determine the value of a currency? Here is an explanation.

The short and long-term movements in the exchange rate, like any price, are caused by changes in market demand and supply conditions.

When the demand for a currency (pesos) is high relative to supply, the Peso goes up in value (an appreciation). The reverse is true when the market supply of pesos exceeds the demand. (A depreciation).

At this point, the economy has a more than the usual level of dollars. Therefore, the Philippines need not exchange Pesos with US Dollars. As a result, the value of the Philippine currency has stabilized/ increased, over the past several months. This is in sharp contrast to the continuous decline, which most Filipinos have gotten accustomed with, for the past several years.

DEMAND FOR PESOS: The surge in demand for Philippine currency comes from the following:

  • Philippine goods and services, including the Overseas Foreign Worker's (OFW’s), are exported overseas, creating an inflow of currency into to the country which needs to be turned into pesos. Por ejemplo, OFW's need to convert their dollars into pesos so they can use it to buy food, television sets, refrigerators and other items in the market.
  • Inflow of Foreign investment.
  • When Market speculators buy huge volumes of Philippine currency, in anticipation of an increase in its value (the intention is to sell it for a profit, at a later time).
  • Official buying of the currency by the country’s central bank.

SUPPLY OF PESOS: Pesos is sold/ exchanged on when

  • Goods and services are imported (pesos are exchanged for dollars to pay for importations or when filipinos go overseas on holiday)
  • Speculators sell pesos for another currency
  • Investment capital flows out of the Philippines.
  • Central banks go into the market and sell pesos to buy other foreign currencies.

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Related Topic: Fluctuating Forex

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