Buzzwords demystified: Currency Edition

Checkout these buzzwords related to currency issuance!

  • Stock-to-flow Ratio: – It is the ratio of the units of a currency already existing(STOCK) to that which can be produced in a year(FLOW). The higher the stock-to-flow ratio, more viable is the currency.
    • Take for instance there are 10,000 units of a currency Q already existing and in a year about 100 new units are produced. This makes its stock-to-flow ratio to be 100(10,000/100). Now assume if 120 new units are produced in a year, that brings the stock-to-flow ratio to about 83(10,000/120). This means that as more new units are produced in a year, the already existing stock will be less valuable. ie. as scarcity reduces, demand reduces.
  • Hardness of Currency: – Hardness of currency is related to the concept of Stock-to-flow ratio. Hardness refers to the difficulty to produce more units of a currency. In other words, that which is hard to produce is hard. The easier a currency is to produce makes it softer.
    • Take gold, for example. These days there is already a huge lot of gold mined out and there is a cap on the volume you can mine out ie. it is hard to produce more. That makes gold Hard and as such a viable currency.
    • Bitcoin is another example of a hard currency.

In other words, that which is hard to produce is hard.

  • Pegging: – pegging refers to the process of tying something to something else. In the context of currencies, it refers to tying the production of a currency to something, mostly whose value would be stable, like gold(gold standard), oil reserves(petro: the Venezuelan cryptocurrency) etc. This is a method to control the value of a currency. In such a situation, in order to produce a unit of a currency, an equivalent value of the pegged commodity must be set aside. This ensures that no new currency is issued unless it is backed by some valuable commodity. The downside being, if the commodity depreciates in value, the currency’s value will also suffer.
  • Reserve Currency: – It is the currency held by Central banks around the world as foreign exchange reserves. It is used for foreign trade between nations in the global economy. Without such a common currency, international trade would have had to follow barter system as the currency of one nation may not hold value in another. The earlier accepted reserve currency was gold. But after the Bretton Woods Conference, United States Dollar($) was accepted as the reserve currency, and remains as the reserve currency even now.

Shreesha S
Shreesha S

Shreesha is a Qualified Certified Management Accountant(CMA) and Certified in Strategy and Competitive Analysis(CSCA).

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