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What Is Numeraire?
Let me explain Numeraire to you directly: it's an economic term from French origins that serves as a benchmark for comparing the value of similar products or financial instruments. The word itself translates to 'money,' 'coinage,' or 'face value,' and that's exactly how it functions in economic contexts.
Key Takeaways
- Numeraire is an economic term of French origin, which acts as a benchmark in comparing the value of similar products or financial instruments.
- A numeraire is usually applied to a single good, which becomes the base value for the entire index or market.
- The U.S. dollar remains the numeraire for most commodity prices.
Understanding Numeraire
You need to grasp that Numeraire represents a unit for measuring prices in economics. I apply it typically to one good, making that the base value for a whole index or market. This setup lets you compare the value of goods against each other straightforwardly. Essentially, the numeraire establishes a standard of value across an exchange, and that's its core role.
Consider how currencies were valued under the Bretton Woods system in the mid-20th century as a clear example. The U.S. dollar (USD) was set at one-thirty-fifth the price of an ounce of gold, and all other currencies were priced as multiples or fractions of the dollar. Here, the USD was the de facto benchmark or numeraire, fixed directly to gold's price.
In today's markets, the U.S. dollar continues as the numeraire for most commodity prices. By denominating these in USD, you standardize the pricing since the dollar is the world's most-traded and liquid currency. For instance, companies dealing in oil can convert payments or receipts quickly because oil prices are in USD.
Setting oil prices in USD also enables a country to compare those values in its own currency. If you're in a nation that's a net oil importer and your currency weakens against the USD, you'll end up paying more for oil in your local terms than before.
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