Why does currency value change

After yesterday's article about conversion between the value ofbritish pounds in the '70s versus british pounds today, someone sent me a link toan article at the National Review Online, which just about had me rolling on the floor laughing. The problem is, it's dead serious.

It's written by an "engineer" named Louis Woodhill, who argues from what he callsan "engineering viewpoint" that the whole idea of fluctuating currency value is total nonsense, and we'd all be better off if we just assigned a fixed value to our currency, and never allowed it to change.

The U.S. dollar is in a scary slide. Gold and oil are hitting record highs,while the dollar is hitting record lows. To get how strange this all seems to an engineerlike me, imagine the following headline: "Foot Falls against Meter for Fifth Straight Day."

The accompanying article would breathlessly report that after the U.S. abandoned its "antiquated" fixed-exchange-rate system (one foot equals 0.3048 meters), our beloved foot began plunging in length. A "length trader" would predict that if the foot fell below the "psychologically important 0.2800 meter support level," it could fall as low as 0.2500 meters. But an economist would say that as long as the foot didn't fall more than 10 percent, everything would be okay.

The story would then describe the plight of a homeowner whose garage was no longer withinhis lot lines. Then another economist would argue that the falling length of the foot wasactually a good thing, because it caused people to be taller, which reduced their "body massindexes," thus fighting obesity. The head of the U.S. Bureau of Standards would be quoted assaying the bureau is committed to "a strong foot," although, "given that imports are longerthan exports, there is only so much we can do." The story would conclude with Paul Krugmanblaming the falling foot on "Bush's tax cuts for the rich."

What is going on with the dollar right now is every bit as ridiculous as the fictional story above. Here's how an engineer would explain the problem.

Economic transactions involve the exchange of "something" for "money." The "something" is specified in terms of number (1, 2, 3, etc.); length/area/volume ("the foot"); weight ("the pound"); and/or time ("the second"). "Money" is specified in terms of "the dollar."

The problem with this scheme is that the magnitude of our fundamental unit of market value, "the dollar," is not defined. Being undefined, the value of the dollar can change. This fact gives rise to huge economic costs and risks for which there are no offsetting benefits.

Sorry, Mr. Woodhill, but that's not how an engineer would explain the problem. It's how a pig-ignorant idiot would explain the problem. The explanation of why is beneath the fold.

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