The demand for currency defines its value just like how the demand for goods and services defines its price in the market. It is nowadays understood that mostly all the currencies are compared to the dollar value; the reason why the US dollar is so much power in the world today. There are majorly three ways through which the value of a currency could be defined:
HOW VALUE OF CURRENCY IS DEFINED?
Firstly, how much the dollar will buy in foreign currencies which are measured by the exchange rate. Foreign exchange traders have a huge role to play here. They determine the foreign exchange rate on a foreign exchange market. This is done by taking into consideration the supply and demand of the currency. This is the reason why the value of the currency changes throughout a trading day.
Secondly, the value of the currency could fluctuate due to the value of treasury notes which can be easily converted into the dollars. It is done through the secondary treasury’s market.
The third way through which the value of a currency can be defined is foreign exchange reserves which are the number of dollars a foreign government holds. If the government holds more, the supply will be lower. This makes the U.S. money more valuable to the governments. If foreign governments decide to sell all their dollar and Treasury holdings, the dollar would eventually collapse. This would result in a huge downfall of dollar currency.