The Theory of Exchange Rate Determination

Is my understanding of a currency peg wrong?

I recently have been reading up on currency pegs and have been getting confused.
I have no formal training in economics or finance, and I have always thought that a currency peg works by a mixture of law as well as supply and demand.
So for example, if a monetary authority of a country called XYZ sets its own currency at $7 XYZ dollars to $ 1 US dollar, commercial banks worldwide have to follow these exchange rate to 7 to 1. The market respects and follows these rate so long as the market thinks and trust it is a fair exchange. This peg is also maintained by how desirable the economy of the country is. So for example, people wants the currency of XYZ because they believe they can use it to buys goods and services and do trading in the economy of XYZ country. Conversely, if the economy of XYZ country is a hellhole, then very few people want that currency, the demand for it goes down because they can't do much with that currency. hence, they will ask for more and more XYZ dollars in exchange for every $US dollar.
Hence, countries on a currency peg or on a free float, would keep forex reserves, using these reserves to buy up their own currency, reducing the supply, and hence, make demand goes up, due to decreased supply.

But I am now reading this investopedia article and these few sentences caught my eye:

"Theoretically, for a currency board to function, it must have at least 100% of reserve currency available, and have a long-term commitment to the local currency. As such, a currency board is required to use a fixed rate of exchange; it must also maintain a minimal amount of reserves, as determined by law."

"Thus, the money base in a currency-board system (M0) is 100%-backed by foreign reserves. A currency board will usually hold a little more than 100% of foreign reserves in order to cover all of its liabilities (issued notes and coins)."

" However, given what we now know about currency boards, it seems hard to imagine how and why the Hong Kong dollar could fall subject to speculation: the currency is anchored at a fixed exchange rate, with at least 100% of the currency's money base covered by foreign reserves (in this case, there were foreign reserves equal to three times the M0). "

Reading the above paragraphs, the impression I am getting is that in Hong Kong's dollar case, for every Hong Kong dollar in existence, it is backed up by an equivalent value in US dollars held b the Hong Kong monetary authority.
Obviously, that can't be possible, because due to a fractional reserve lending system, Hong Kong dollars are being created all the time, there is no way for the HKMA to keep track of all the Hong Kong dollars being created into existence by the act of lending.
Also, I think that HKMA's forex reserves are initially gained by exchanging HK dollars with other banks, hence, it can't be possibly for HKMA to have more forex reserves that HK dollars.
Am I missing something here?

submitted by curioustraveller1985 to AskEconomics [link] [comments]

New rule! Also are cryptocurrencies an investment, will there be a crash? Everything answered here!

This is going to be the only crypto post for now and an announcement:
Rule 6: Bitcoins & cryptocurrenies should be discussed in CryptoCurrency. Posts regarding this topic will be automatically removed.
If there's a stock correlated with cryptocurrencies, like coinbase going IPO, then that's fine, you might have to message the mods after posting to have it approved, no big deal.
Also if you're questioning whether something is an investment or not, just search for it on personalfinance. For general currency trading strategies, see forex .
If you're wondering if bitcoins are an investment or if there will be a crash, read on.

Are cryptocurrencies an investment?

This post is going to deal with bitcoins & cryptocurrencies as an investment... they're more speculative. All currencies are speculative mostly due to how the forex market works, but more because of exchange rates between countries keep currencies balanced (including inflation, country debt, interest rates, political & economic stability, etc), so you can only profit in price fluctuations.
Sure you could buy the currency of a depressed country, like Mexico decades ago, and then hold in the hopes it'll go up (which it did for Mexico), but that's also speculation (no one knew Mexico would pay off so much debt).
Bitcoins are also affected by other countries' currency values, but more so by the future expectation of legitimacy, world wide adoption, limited gains from mining, and eventual limit in supply. But at any given moment the United States could pay off more debt, raise interest rates to reduce inflation (or cause deflation), grow GDP, or even reduce the supply of USD all of which would increase the value of USD (keep in mind bitcoins can't do any of these things).
Far too many people are treating cryptocoins as an investment because currently (June 5th 2017) a lot of crypto investors are worth a lot of money, god bless you people, so this post will also help you determine if we're headed for a crypto crash and maybe you can keep those profits.

Should I invest in cryptocurrencies?

Understand that an investment is something you hope will go up in the future or provide income, both of which for the long term vs speculation which profits on short term inefficiencies.
Speculative securities are typically commodities, options, bonds, and currencies, but also stocks that are volatile enough to give you extreme returns or extreme loses.

Examples of investments:

Examples of speculation:

Reducing the risk of speculation

Typically for speculation you reduce risk by reducing your trade size and timeframe, but since you're trying to invest into something that is speculative, you can try:
Asset allocation, a strategy that reduces risk.. If you're 80% stocks, 15% bonds, 4% gold, and 1% bitcoins, if something were to happen to bitcoins, you still have 99% of your money.
But even very aggressive long term portfolios leave speculation out completely and just go 100% stocks because stocks benefit from growth while speculative securities like gold benefit from global turmoil in the short term. Only mid risk & mid term portfolios can take advantage of gold's speculative returns.
I also mention asset allocation because many crypto investors have been using this strategy on a portfolio of 100% crypto coins, but that doesn't help you reduce the overall risk of crypto coins, you're just reducing the risk of 1 speculative asset with another speculative asset. 100% crypto portfolio would face the same risks such as being made illegal, IRS aggressively hunting down crypto profits, a drop in correlated coin markets, or just a loss of popularity would all cause a sell off. Even the USD or Chinese currencies becoming more valuable would reduce the value of crypto coins.

Should I buy coins right now?

Cryptocoins are a better investment after a period of consolidation when volatility has stabilized:

Bitcoin 2013/2014 speculation, chart

Bitcoin 2015 consolidation, chart

Source Bitstamp exchange, while the volume is #2 to GDAX, Bitstamp is better to look at for historical price/data, more charts here.

RSI & MACD key for above charts and primer

Analyzing overbought signals

So the first chart above have RSI & MACD screaming that bitcoin is overbought and you shouldn't invest in 2013/2014.
The black squares in the 2nd chart show consolidation and reduced volatility, a "better" time to invest. If you were trading short term, it would be a whole different story, and there would be opportunities to buy & short, but since this is written for investing, the small overbought signals are ignored, so if you were to buy Bitcoin at $300 inside the first blacksquare (2nd chart) and then it suddenly drops to 25%, it's okay because the volatility is much lower compared to previous price movements (nothing compared to 80% loss in the 1st chart). Any investor would tell you a 25% drop is terrible, but bitcoins are speculative and that kind of drop is pretty damn good for this level of volatility.

Nothing goes straight up forever

and anything that comes near this vertical incline will eventually lose 80% to near 100%, always happens, it's usually preceded by emotions (price euphoria), attention, and increased volume, all classic signs that something is becoming riskier.
Other speculative securities gaining multiples and then losing 80% to near 100% of value:

Notable comments on reddit:

*This is just to get you guys looking at different subs on this topic, and yeah it's mostly anti-crypto, but don't let that discourage you.

Is Bitcoin going to crash?

Maybe, the signals are getting louder, you tell me: The only chart you wanted to see this entire time.
So based on the above chart, is bitcoin overbought? MACD levels are the same as 2013's crash, but the increased in value is around 4.3x or 2.4x (depending on which you look at), so maybe we'll see another spike before a crash, I don't know, it's up to interpretation right now. There's the emotional price levels of 3000 and 4000 that we might have no problem getting to in an overbought environment before a correction. And how big will the correction be? I think 80%, but it very well could be around 50% down to $1200, the previous level of resistance which would become support.
I put everything above in its own wiki here.
Well I hope that helps everyone. Sorry to anyone that may feel butthurt on classifying cryptocoins as speculation, I hope you understand the facts. Feel free to argue or agree with this. If I made any mistakes and you point them out, I'll correct them and give you credit for it in an update to this post and the wiki.
Also the automod will is just going to blanket remove posts (not comments) with the following keywords {crypto, bitcoin, btc, etherium, altcoin} (see update 4 below) (this will eventually get relaxed if Coinbase ever IPOs) and then it'll send the user this message:
"Sorry your post[link] was removed in stocks because of rule 6: Bitcoins & cryptocurrenies should be discussed in CryptoCurrency. You can find more information in our are-cryptocurrencies-investments wiki. If you're trying to discuss a non-OTC stock related to cryptocoins like Coinbase IPO, or this was just a mistake, message the mods and they'll approve your post, thanks."
Update: Created wiki, added relevant websites and sub reddits. Also turned on automod reply.
Update2: those relavant websites and subreddits I put into the wiki, thanks u/dross99 for recommending ethereum

Relevant websites/wikis

Relevant subreddits

  • CryptoCurrency - main sub to learn about all bit & altcoins
  • ethtrader - trading eth
  • ethereum - for more eth information
  • btc - the place to have bitcoin discussions or r/CryptoCurrency; while Bitcoin does have a lot of information on Bitcoins in general, you'll find many reddit subs completely opposed to Bitcoin for heavy censorship of discussions, especially those critical of bitcoins, so you're better off reading the sub's wikis and discussing bitcoins in btc & r/CryptoCurrency
  • personalfinance
Update3: Shoutout to the mods on CryptoCurrency
Update4: Updated auto mod keywords, it's not a blanket catch all, a little completed to understand if you don't know regex but it looks like this
"crypto ?(trading|investing)","(should(| I)|could(| I)|can(| I)|how to|is it worth) (buy|sell|mine|min)(|ing) (btc|btcs|bitcoin|ether|etherium|eth|litecoin|ripple|altcoin)" 
submitted by provoko to stocks [link] [comments]

Naive Optimism?

I made this comment in an earlier post and was just wondering if anyone could clarify my mistakes in considering what XRP could be.
"In an interview with Fortune, Ripple CEO Brad Garlinghouse said the role of specific events is overstated in assessing the value of XRP. Instead, he attributed the currency’s value to its usefulness for processing transactions, and its ability to provide liquidity for big banks."
In regards to liquidity, today $10 may seem volatile but maybe using an example of gold in 1920 might help. Gold backed fiat currencies made exchange easier because rather than pegging one fiat to another (USD/Yuan) we had an asset everyone agrees represented overall supply. At the moment our system is subject to the strength of a nations currency to determine stability(import/export) However if we experience a large recession this can cause an avalanche effect(2008-2012 Great Recession) with global instability. If we have an agreed asset for exchange such as XRP for settlements then that would essentially be what gold was and prevent severe recessions(limit global impact).
Banks make large transactions, so considering banks in 1920 utilized gold and $20 was seen as a common denomination to transfer funds. With 1100% inflation until 2017 what would it be worth in today's dollars? Approximately $255.48, considering the population and production capacity of the time that would probably change to something higher.
I'm not claiming that XRP is gold, or will be a standard. However when banks start utilizing XRP they may be more concerned with its value than that of other currencies. Which would place a high demand on it and I can't see why that wouldn't be a big picture view for the future. If 2500 banks used XRP this way I can't see how exponential growth couldn't happen. Also it is a deflationary asset so enough holders and that will just multiply it's value along with escrow limiting supply.
I could just be totally wrong though, lol.
submitted by Destruktum to Ripple [link] [comments]

For Beginners: Stablecoins: Explaining what stablecoins are and why they’re so important for the cryptocurrency industry

For Beginners: Stablecoins: Explaining what stablecoins are and why they’re so important for the cryptocurrency industry
With the seemingly endless amount of coins entering the market each year, we are beginning to see various categories of digital assets emerge. One of these classifications of coins is known as stablecoins, and although you may see it as ironic that a cryptocurrency is labeled as being “stable,” that’s actually exactly what they are known for. Stablecoins make up a unique category of coins in the market that are poised to bring stability and trust back into the cryptocurrency market. With that being said, let’s go over what stablecoins are and why they are so important for the development of the cryptocurrency industry as a whole.
This is not financial investment advice. This article will touch upon key aspects of what stablecoins are and why they can help the growth of the crypto industry.


Blockchain: The easiest way to understand blockchain is to think of it as a fully transparent and continuously updated record of the exchange of information through a network of personal computers, a system which nobody fully owns. This makes it decentralized and extremely difficult for anyone to single-handedly hack or corrupt the system, pretty much guaranteeing full validity and trust in each exchange of information.
Volatility: The rate at which the price of a security increases or decreases for a given set of returns. Volatility is measured by calculating the standard deviation of the annualized returns over a given period of time. It shows the range to which the price of a security may increase or decrease.
Fiat: Currency that a government has declared to be legal tender, but it is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material from which the money is made.
Decentralization: Essentially, if something is centralized, there’s a single point that does all of the work involved in any given action. On the flip side, if something is decentralized, there are multiple points that do the work.
Familiarize yourself with these key terms in order to better understand what stablecoins are.

What Are Stablecoins?

To put it simply, stablecoins are cryptocurrencies that are pegged or backed by some other asset. Some forms of stablecoins are tied to assets such as the dollar or a commodity like a bar of gold or a barrel of oil. Other forms of stablecoins are backed by cryptocurrencies, or even exist as self-correcting, algorithmically-controlled systems. Essentially, stablecoins hold the promise of a half-step between traditional assets and crypto assets, taking the best from both worlds while resulting in a much more accessible and efficient form of finance.
The concept of having a stablecoin of stable currency isn’t new, as governments have been considering the implementation of this idea for quite some time now. National governments have the same motivation as crypto economies to deal in stable assets, as volatility in any kind of currency scheme can lead to wild speculation and boom and bust values. Historically, there have been a few different ways of implementing currency pegs at the national scale. Some countries just start using another country’s currency in lieu of their own as legal tender. Other governments have decided to set a fixed peg, while others determine an acceptable range and let their currency float within a range in relation to the peg.
Even within the cryptocurrency world, people have been experimenting, with mixed results, with stablecoin design and setup. Tether is one of the most prominent stablecoins, which is a blockchain-based cryptocurrency whose coins in circulation are backed by an equivalent amount of traditional fiat currencies, like the dollar, the euro or the Japanese yen, which are held in a designated bank account. Tether tokens, the native tokens of the Tether network, trade under the USDT symbol.
Stablecoins are cryptocurrencies that are backed by another asset, such as fiat money or another algorithmically-controlled system. This keeps the value of that coins stable and lowers the threat of high volatility.

How Can They Impact The Crypto industry?

By definition, stablecoins are inherently different than the rest of the cryptocurrencies in the industry, as their value is determined and derived differently. With all the criticism and skepticism surrounding the industry today, many people have pointed to stablecoins as being one of the biggest proponents in legitimizing the cryptocurrency market as a viable asset class.
Stablecoins could quickly become the universally accepted, international currency of the future. They have the potential to empower everyone to take part in an evolving crypto-economy, without compromising security and freedom. If implemented at scale, they are poised to become a foundational component of the next-generation economy. One of the biggest attacks against the cryptocurrency market is that the coins are too volatile and that they have no safe backing. Stablecoins solve both of those issues while still serving as a digital asset that can perpetuate excitement for the market as a whole.
Stablecoins solve the issue of volatility and lack of inherent value by having an actual asset which determines its value. At this point, they can serve as mediums of payment and monetary value while maintaining a stable price.


Sure, the cryptocurrency market may be filled with coins that are highly volatile and may not have the backing of inherently valuable assets, but what if there were coins that could satisfy all of these points? Well, with stablecoins, all of these issues are solved and the possibility of using these coins as mediums of payments becomes real. Imagine having the ability to use a cryptocurrency that is essentially valued the same as other widely-used assets like fiat money, oil, or even gold? The digital asset economy is quickly revolutionizing the world, so keep an eye out for this category of cryptocurrencies to one day become the future of the industry.
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determination of exchange rate Live Forex Webinar Understanding Forex Quotes Investopedia Videos Chapter 4 Exchange Rate Determination Determinants of Foreign Exchange Rate - YouTube Foreign exchange rate and its types - YouTube Main Factors that Influence Exchange Rates - YouTube

The determination of rate of exchange through monetary approach can be derived as below: There are two countries India and the U.S.A. denoted as countries 1 and 2 respectively. The monetary equilibrium in each of them is determined when the demand for money (M d) gets balanced with the supply of money (M s). M d1 = M S1. M d2 = M S2. The subscripts 1 and 2 denote the two countries. M S1 = K 1 ... Exchange Rate: An exchange rate is the price of a nation’s currency in terms of another currency. Thus, an exchange rate has two components, the domestic currency and a foreign currency, and can ... A floating exchange rate is a regime where a nation's currency is set by the forex market through supply and demand. The currency rises or falls freely, and is not significantly manipulated by the ... Free app! Access all videos on this channel by putting into your phone browser and follow the instructions This video looks at quirements for any theoretical model of exchange rate determination to be consistent with these empirical regularities. ’ 1. Empirical regularities in the behavior of exchange rates and their implications for ex- change rate theory are discussed in Mussa (1979); see also Dooley and Isard (1978), Frenkel and Mussa (1980), lsard (1980), and Frenkel (1981). 15 The Theory of Exchange Rate ... Exchange Rate Determination: Now two pertinent questions that usually arise in the foreign exchange market are to be an­swered now. Firstly, how is equilibrium ex­change rate determined and, secondly, why exchange rate moves up and down? There are two methods of foreign exchange rate determination. One method falls under the classical gold standard mechanism and another method falls under ... The exchange rate, in the long run, needs to be at the level which a basket of goods costs the same in two currencies. Thus, if a Mickey Mantle rookie card, for instance, costs $50,000 Canadian and $25,000 U.S., the exchange rate should be two Canadian dollars for one American dollar. Still, the exchange rate is actually determined by a variety of factors, which change constantly. As a result ...

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determination of exchange rate

FOREX trading basics: A fun & easy format for ALL to understand! Part 1 of 2 ... Beginners Guide to Forex by Investopedia - Duration: 1:49. Kiss Trading Academy 1,264 views. 1:49. What are Base ... In this video I am explaining the topic of Foreign exchange Foreign exchange rate Currency depreciation Currency appreciation Types of foreign exchange rate ... This video discusses Chapter 4 Exchange Rate Determination from book entitled International Financial Management, 7th Edition by Jeff Madura, Florida Atlantic University. Determinants of Foreign Exchange Rate watch more videos at Lecture By: Ms. Madhu Bhatia, Tutorials Po... determination of foreign exchange rate ( forex rate )in foreign market with force of currency demand and supply The exchange rate is one of the most important determinants of a country's relative level of economic health. It plays a vital role in trade, which is critic... By Investopedia Staff What Is Forex? The foreign exchange market is the "place" where currencies are traded. Currencies are important to most people around the world, whether they realize it or ...