Checking Out Currency Categories - dummies

By Consumer Dummies

Money is a medium of exchange. It’s just a tool that people use to exchange their labor for the things they want and need. If you have only euros and you want to buy something priced in rubles, you have to trade your euros for rubles. As long as you can trade your money, you’re happy. Whether — or how easily — you can make an exchange depends on the category into which a currency falls:

  • Hard currency: A hard currency is one that can be exchanged easily for other world currencies. The prices of hard currency are readily available, so both parties know whether they’re getting a good deal. Because hard currency can be spent outside of a country and converted to other currencies, it’s the most valuable type of money.

    The hardest of the hard currencies are associated with the world’s most developed economies: the U.S. dollar, the Canadian dollar, the Australian dollar, the Swiss franc, the Japanese yen, and the European Union’s euro. Some emerging-market currencies are nearly as strong as these.

  • Soft currency: Currency that can’t be exchanged is known as a soft currency. A true soft currency can’t be exchanged on the open market (but quite possibly can be exchanged on the black market for either hard currency or contraband goods). When a currency is soft, international trade takes place in a hard currency, probably the U.S. dollar or the euro. This adds to the cost of doing business in a country. And a soft currency means that investors in a country may have a difficult time getting their cash out.

    Some countries have two currencies — a soft currency for domestic use and a hard currency for foreign exchange. In this situation, the hard currency is much more valuable than the soft currency. If you’re exchanging money, make sure that you know which is which.

  • Dollarized currencies: The U.S. dollar is the world’s numeraire, or primary currency for trade, investing, and national reserves. Many international transactions take place in dollars, no matter what currency is used by the countries involved.

    Many nations have tied their currency to the dollar in some form or another. Some use a fixed exchange rate of their currency to the dollar. Others simply choose to use the dollar rather than their own currency; the technical term for that is dollarization, and it mostly happens in very small countries or in countries that have experienced tremendous upheaval in their national economy. Countries that use the U.S. dollar include East Timor, Ecuador, El Salvador, and Panama. They don’t need any permission or approval from the United States to use the U.S. dollar, either.

    The Australian and New Zealand dollars are also used in Pacific islands near those countries, and the British pound is still the primary currency in a handful of former British colonies.