What actually gives currency value?

Faith.

It used to be some valuable resource like gold or oil, now it is just lie @pdworkin says faith and people are becoming agnostic.

Supply and demand in the free international FX markets (handled by banks). Unless a currency gets excluded, like in China. Their central bank defines the rate.

Differences in interest rates for example can make a particular currency more or less attractive. Another factor is regional inflation.

The same thing that gives anything value: agreement. When people agree that something has value, they are willing to pursue it. What gives gold value? It’s just a metal—people want it for jewelry, or they want it because they can trade it for money, which they want because they can trade it for other things they want.

I suppose you could say “wanting” is more fundamental than “agreement”, but without agreement you wouldn’t have money.

Currency, like @pdworkin says, is faith-based – even moreso than just the “in God we trust” would imply. Currency has value because people believe it has value, and are willing to trade it for goods, services, and other instruments of value.

There are people that speculate in currencies. If they hold, say, a million Euros but feel that the Dollar would be more stable/valuable, they might trade their euros for dollars at whatever rate someone wishes to trade their dollars for euros. It’s a lot like the stock market. And when lots of people want to buy something (dollars, for example) the value of the dollar goes up because the holders of dollars, as owners of a commodity in high demand, can set the price they want to sell at. And if everyone is selling something (like Euros, or General Motors stock), the price goes down. It’s a little bit like a self-fulfilling prophecy.

No, it’s not only faith based. FX traders use tons of data and analysis schemes. Like with the stock market psychology/faith is a very important factor when making educated guesses about the future. But not the only one. As an example, before some central bank announces interest rates there’s a lot of speculation about it will go this or that way. And this (faith) influences the FX rates. After the actual announcement the rates can change too, sometimes significantly, especially when there were surprises.

@mattbrowne When people lose faith in currency, no amount of number crunching can bring it back. We have seen it between the two World Wars in Germany, in the US, more than once in the Soviet Union, and we are seeing it now in the record high commodity price for gold.

The currency of each country denotes it’s perceived ability to trade an equitable value for it’s goods and services.

An extreme example is in Zimbabwe a $100,000,000,000.00 bank note will buy you 3 eggs.

@pdworkin – Faith is a factor. But it’s not the only one. With Mugabe Zimbabwe has no future. Nobody believes in the future. That’s the faith component making it unattractive to buy Zimbabwean dollars. However, the number crunchers will use real data. And not just gut feelings. Their results will influence the exchange rate as well. For example a recent history of inflation. Obviously only billionaires are able to buy eggs.

All the goods and services in the world = all the currency in the world. I.e., the currency is a stand-in for things we value because it’s hard to carry a piano or a supertanker around with you to trade for three cars or a building in Los Angeles. So, instead of bartering for things, we use currency as a stand-in.

The trust or belief part comes in because we have to all agree that our currency is accurately measuring the agreed-on value of goods and services. In recessions, people start to believe that things are over-valued. So the value of currency has to decline (it takes more to pay for less). There are still the same amount of things and stuff that people do out there, but, because we no longer have faith in the relationship between currency and goods and services, the economy declines. People stop doing as much work, because no one wants it any more, because everything is uncertain.

Governments can mess with things by pumping more currency into play. At first, people buy stuff and this stimulates production, but if the government puts in too much currency, then it will decline in value until it comes into equilibrium with our collective sense of the actual value of things compared to the amount of money in the system.

There’s a lot more to say, but I can’t give an economics class here.

Wow, it seems as though the world economy is exceptionally fragile. So ultimately, people make value and break value of the system. Is there safeguards in place that would keep our currency from falling to levels like those in africa?

Oh yes. There are safeguards…. in some countries. But they aren’t perfect because we can’t think of everything that could mess up the system.

In Africa, the leaders often don’t understand economics. They think if they print money, then there is more money. Unfortunately, the real value is the things that people make and do, and that doesn’t change, no matter how much money you print. So if I have ten dollars and that equals all the stuff I make. Then I print 90 more dollars so I now have 100 dollars. It still equals all the stuff I make. But now each dollar is worth a tenth of what it was when there were only 10 dollars in existence.

What is necessary to keep it all stable is confidence. It works when we all have confidence in it, and when we lose confidence, the economy suffers as people no longer believe that what they do and make will be accurately reflected by the currency.

So, in the recent mortgage crisis—people believed the mortgages were worth so much, and that was all backed by property worth a little more. But it turned out that the people had borrowed more than they could pay, and their houses had been overvalued to justify those mortgages, and so it collapsed, together with our confidence in mortgage bankers.

Now, to regain confidence, we need to slap stricter rules on the bankers to make sure they don’t fuck it up again. If they want to cheat, they’ll have to do it in a new way. And believe me, eventually they will find that way. But we hope the rest of the system is solid enough (with enough confidence) that the harm will be minimal.

Confidence – when people are confident in their currency/economy then they become stronger relative to other currencies.

The more confident the people involved in money markets feel about the present and future productivity of a countries economy, and the more demand there is for the commodities that country produces for export, the more vibrant and stable their economy looks and the higher the value ascribed to their unit of currency.

I hope this answer is clear and straight forward. Of course the fine points of world economics are much more complicated than I understand or can explain.