A:

Generally speaking, when Country A's currency is worth more than that of Country B, it does not necessarily mean that Country A's economy is stronger than B's. For example, Japan's economy is regarded as one of the world's strongest, and yet a single Japanese yen exchanges for considerably less than US$1. On the other hand, Cyprus' economy is considerably smaller than the U.S. economy, but Cyprus' currency, which is the pound, exchanges for about twice as much as the U.S. dollar.

The fact of the matter is that looking at a currency's worth relative to that of another currency at a static point in time is meaningless; the best way to judge a currency's worth is to watch it in relation to other currencies over time. Supply and demand, inflation and other economic factors will cause changes to a currency's relative worth, and it is this change in value that can be used to evaluate worth.

For example, let's say that at the beginning of the year, the U.S. dollar was worth 1.75 XYZ dollars (a fictitious currency), and six months later, the U.S. dollar is worth 2.00 XYZ dollars. In this case, the U.S. dollar increased in value over the XYZ dollar by around 14%. This change could be due to XYZ having higher inflation, or to just an overall lower demand for the XYZ dollar.

A currency's purchasing power can also be used as an indicator of the relative worth of currencies. For example, if US$1 can be exchanged for XYZ$1, it would appear that the XYZ dollar is worth as much as the U.S. dollar. However, if the purchasing power of XYZ$1 is equal to only US$0.50, then you can conclude that the U.S. dollar is worth more than the XYZ dollar, because a single U.S. dollar can be used to buy more goods than a single XYZ dollar can.

To learn more about currency trading, see Commodity Prices And Currency Movements, Wading Into The Currency Market and Common Questions About Currency Trading.

RELATED FAQS
  1. What is the difference between a long position and a call option?

    Learn what a long position in a stock is, what a call option is, and the difference between owning shares of a company and ... Read Answer >>
  2. Why would my stock's value decline despite good news being released?

    More often than not, when a firm releases an earnings report the market will react to this news by adjusting the firm's stock ... Read Answer >>
  3. What is foreign exchange?

    Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's ... Read Answer >>
  4. What are key economic factors that can cause currency depreciation in a country?

    Read about the causes of currency devaluation, and find out how to differentiate between relative and absolute currency devaluation. Read Answer >>
  5. How do changes in national interest rates affect a currency's value and exchange ...

    Generally, higher interest rates increase the value of a given country's currency, but Interest rates alone do not determine ... Read Answer >>
Related Articles
  1. Investing

    Explaining Fixed Exchange Rates

    A government using a fixed exchange rate has linked the value of its currency to the value of another country’s currency, or the price of gold.
  2. Investing

    Currency Swap Basics

    A currency swap involves two parties exchanging a notional principal and interest to gain exposure to a desired currency.
  3. Trading

    Profiting From a Weak U.S. Dollar

    Learn how to allocate your investments when the U.S. dollar is down.
  4. Trading

    Play Foreign Currencies Against The U.S. Dollar And Win

    Don't panic when the dollar drops. Learn to exploit the greenback's decline and profit from it.
  5. Trading

    Top 5 Hardest-Hit Currencies

    The value of a country's currency is dependent on many factors that will cause it to fluctuate, relative to other world currencies.
  6. Taxes

    How Your Government's Budgetary Decisions Impact the Public Sector

    Issues facing the public sector are not unlike some issues facing America’s oldest and largest companies, but with larger and broader impacts.
  7. Trading

    Drastic Currency Changes: What's The Cause?

    Currency fluctuations often defy logic. Learn the trends and factors that result in these movements.
  8. Trading

    Top Economic Factors That Depreciate The $US

    A variety of factors contribute to currency depreciation, including monetary policy, inflation, demand for currency, economic growth and export prices.
  9. Investing

    What Is Year Over Year?

    Year over year measures performance in one time period versus performance in a previous time period.
  10. Trading

    Interest Rate and Currency Value And Exchange Rate

    In general, higher interest rates in one country tend to increase the value of its currency.
RELATED TERMS
  1. International Currency Exchange Rate

    The rate at which two currencies in the market can be exchanged. ...
  2. Currency

    Currency is a generally accepted form of money, including coins ...
  3. Currency Appreciation

    An increase in the value of one currency in terms of another. ...
  4. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  5. Accounting Currency

    The monetary unit used when recording transactions in a company's ...
  6. Weak Currency

    A currency with value that has depreciated significantly over ...
Hot Definitions
  1. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  2. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  3. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  4. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
  5. Long Run

    A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all ...
  6. Quasi Contract

    A legal agreement created by the courts between two parties who did not have a previous obligation to each other. A normal ...
Trading Center