2 Basic Questions on Stock Markets

[AK]

Very basic.



How is the value of a currency determined by the stock markets?
Is investing really that common for the average individual (in a place such as Australia) that investment advisors prop up all over the place and stockbroking firms have heaps of ads on tv?

[mikelepore]

How is the value of a currency determined by the stock markets?

It's not at the stock market. It's at another place called the forex or FX market, which means foreign exchange. There the speculators trade "currency pairs", for example, a person who announces "I'll give 2 dollars to anyone who will give me 3 euros" and another person who announces "I'll give 3 euros to anyone who will give me 2 dollars" get matched up. Most of this process for the whole world is done in London, but remote computer terminals in other countries make it done "over the counter."



Is investing really that common for the average individual (in a place such as Australia) that investment advisors prop up all over the place and stockbroking firms have heaps of ads on tv?

Investing is increasingly common since the 1980s when no-load mutual funds began to allow complete diversification with very little money. The main problem for the working class is the small size of the principal. Instead of putting your 100 dollars in the local bank, you can now put your 100 dollars into a diversified basket of stock and bonds across six continents -- whoopie. You're still poor if you only have 100 dollars, no matter how exotic sounding the institution may be.

You can also write a check to take the money back out. In the U.S., the main inconvenience that prevents people from using this for all their short term checking account purposes is the fact that every check is a taxable event. For example, if you write a check for 50 dollars, now you have to figure out whether that 50 dollar redemption took some form like a sale of 2.502 shares at 19.984 dollars per share, but you bought them at 18.002 per share, so don't forget to record that capital gain on your next annual income tax form, otherwise you'll go to prison. If not for that record-keeping nightmare, the working class would now be using stock mutual funds as their regular checking accounts that they use to pay their monthly household bills.

[Demogorgon]

With regards to what MikeLepore said about ordinary people investing, the amounts are largely insignificant. The more important thing though is that pension funds that most people are paying into are perhaps the biggest investors in the stock market today. This means there has been a shift from the way it worked in the past, but power can hardly be said to rest with those in the pension plan. Rather those who run it.

[Lyev]

It's not at the stock market. It's at another place called the forex or FX market, which means foreign exchange. There the speculators trade "currency pairs", for example, a person who announces "I'll give 2 dollars to anyone who will give me 3 euros" and another person who announces "I'll give 3 euros to anyone who will give me 2 dollars" get matched up. Most of this process for the whole world is done in London, but remote computer terminals in other countries make it done "over the counter."
In the media and suchlike I hear a lot of talk about a contest between the US dollar and the Chinese yuan; how is such "currency pairing" conducive to the de-valuing/re-valuing of either (or in fact any) currency? Why is it that some currencies (i.e. the dollar or the yuan) are more dominant in the world market than others? Does a recession (like the current one) affect these parameters at all? Thanks for any answers in advance.

EDIT: I just thought of another question. Sorry if it's an awful lot of questions at once. Well basically, in August this year I'm travelling to Nepal and instead of using the Nepali rupee, the organisation I'm going with have encouraged everyone on the trip to use the U?S dollar instead, and exchange our British sterling for that instead. How does such an influx of foreign currency effect (an especially poor) country like Nepal? And should I exchange my sterling for Nepali rupees instead? Thanks very much again.

[Demogorgon]

The Chinese currency isn't traded in the manner Mike explained, but rather it is pegged to what is called a basket of currencies. Off the top of my head I can't remember what these are, but they will included Dollars, Euros, Sterling, Yen, probably Swiss Francs and so on. Based on the value of these different Currencies, the trading value of the Yuan is determined.

As for the general question though of why some currencies are considered more valuable than others, well it is fairly obvious. The "Hard Currencies" (US Dollar, Euro, Sterling, Yen and Swiss Franc) have an established track record, are based in strong and important economies and aren't going to be wiped out by inflation.

Often when you hear about the value of currencies though, what is really meant is how it will affect prices between countries and thus trade. For instance, say the dollar falls in value against the Sterling. It will then become cheaper for British consumers to buy American products. The downside is the first of all British companies may find it harder to compete and secondly they will find it much harder to sell to America. On the other hand if the value of the dollar rises again, while it becomes easier to sell to America. American products become more expensive.

As for Nepal, you should definitely change to Dollars. For one people might not even accept local currency, Dollars being clearly more useful to people there. In many cases Dollars and Euros are the De Facto currencies of many places when the local currency has lost credibility. At any rate, you can lay your conscience to rest, gaining access to Dollars will probably help Nepal's economy in the short run because in doing so it can first of all buy more from abroad with greater ease and also builds up a reserve to back its own currency.

[mikelepore]

Quoth the Wikipedia article entitled "Fixed exchange rate":

"Typically, a government wanting to maintain a fixed exchange rate does so by either buying or selling its own currency on the open market. This is one reason governments maintain reserves of foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys its own currency in the market using its reserves. This places greater demand on the market and pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the opposite measures are taken. Another, less used means of maintaining a fixed exchange rate is by simply making it illegal to trade currency at any other rate. This is difficult to enforce and often leads to a black market in foreign currency. Nonetheless, some countries are highly successful at using this method due to government monopolies over all money conversion. This is the method employed by the Chinese government to maintain a currency peg or tightly banded float against the US dollar."