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Value of Money


Value of Money

In most countries, the value of money is determined by its currency.

(Photo: Getty Images)

The Value of Money in the U.S. Is Measured by the Dollar:

The value of money in the U.S. economy is measured by the value of the dollar. The dollar is valued in three ways. The first is against its value to other countries' currencies, through the exchange rate. This fluctuates daily. Second, the dollar's value is measured by Treasury notes, which can be converted easily into dollars, and are auctioned daily. Third, the dollar's value is measured by foreign currency reserves. This is the amount of dollars held by foreign governments. No matter how measured, the dollar's value has been declining thanks to a low Fed funds rate, a high Federal debt, and a slow-growth economy.

How Does It Affect You?:

You notice the value of money most directly at the gas pump and at the grocery store. That's because the prices of gas and food are inelastic. This means that you pretty much have to buy gas and food every week, so producers know they can pass on increased costs and you'll buy it at that price for a while before reducing your demand for that item. When the price of gas or food goes up, you are experiencing the reduced value of money.

When the Value of Money Steadily Declines:

Inflation is when the value of money steadily declines over time. Once people expect that prices will rise, they are more likely to buy now, before prices go higher. This increases demand, which tells producers they can safely pass on more costs. This drives prices up more, and inflation becomes a self-fulfilling prophecy. That's why the Federal Reserve watches inflation like a hawk, and will reduce the money supply to curb inflation. However, a healthy economy can sustain a core inflation rate of 2%. Core inflation is the price of everything except those volatile food and gas prices. Inflation is measured by the CPI.

When It Increases:

Deflation is when the value of money increases. That sounds like a great thing, but it is actually worse for the economy than inflation. Why? Think about what happened to the housing market from 2007-2011, when there was massive deflation. Prices dropped more than 20%, and many people could not sell their houses. People were afraid to buy because they didn't want to lose the value of the home. True, the value of money increased - you got more home for the dollar than in 2006 - but no one knew when prices would turn back up. Homes and jobs were lost. That's what happens in deflation - it's a downward spiral of fear.

How Has the Value of Money Changed Over Time?:

In 1913, money was worth a lot more. A dollar then could buy what $22 bought in 2010. The dollar lost value slowly. By 1920, it could buy what $10 does today. During the Depression, money gained in value. It could buy what $13 does today. By 1950, money had lost some value. A dollar could buy what $10 does today. Money has been losing value ever since. In 1970, it could only buy what $5.62 could buy today. By 1990, it was only worth $1.67 in today's terms.

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