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How much currency can a country print?

This question has troubled me for years.

In India, The Reserve Bank of India (RBI) is the authoritative central bank that decides how much money have to be printed based on India's monetary policy. The policy that determines the amount of money that should be in circulation in the country. Determination of such monetary policies is pretty complex as lot of factors have to be considered.

So, the pertinent question, since a country can print its own currencies, why can't they print so much so that everyone has enough currency wealth, thereby eradicating poverty completely?

Assume there is a country with only three people living; Ram, Rahim and Gopal and each has personal wealth of Rs  300, Rs 200 and Rs 100.

So the total wealth of this country is 300 + 200 + 100 = Rs 600.

Consider there is only one commodity available in the country that can be purchased by its citizens. Lets take it as this country has total 60 kgs of rice that its people can buy.

By dividing total wealth of the country and total available commodity (rice), we calculate how much should 1 kg of rice cost. 600 / 60 = Rs. 10 per kg.

At this rate, Ram, Rahim and Gopal can purchase 30kg, 20kg and 10kg accordingly using up all their wealth.

One fine day, they get hold of a currency printing machine and decide to print more to double up their wealth. Now, each has a personal wealth of Rs 600, Rs 400 and Rs 200 and the total wealth of the country is now  600 + 400 + 200 = Rs 1200.

The revised cost of rice is = 1200/60 = Rs 20 per kg.  

Now they go to buy the rice. At this new rate, all three could still buy 30kg, 20kg and 10kg rice; only later they realize how futile it was to print currencies to double up their wealth. Though they've increased the personal wealth, they couldn't buy more kgs of rice than before.


Merely printing more currency will do no good to anyone. If they really wanted to become rich, they should've increased the production of rice. With no increase in production and with their wealth doubled, the value of the currency got halved.

You can extend the same concept to any country. For eg, if RBI decides to print more currency and have it in circulation, every one will get money out of nowhere, the cost of goods would also increase accordingly; since everybody is has more cash, everybody would want to buy a Mercedes and the price of a Mercedes would also increase. Simply put, the law of supply and demand.

This could lead to increase in prices of all goods in the country causing inflation and some extreme cases, hyperinflation.

    (to buy a loaf of bread) 
The economic scene of Zimbabwe in 2015 is the best case example of hyperinflation. Due to printing of more currency than required and with no increase in production, the prices of goods have skyrocketed.
                                                          
The price of one loaf of bread cost 35 million Zimbabwe dollars and their currency has a value of 35 quadrillion dollars with respect to 1 USD.


Therefore to become rich, the country (its people) has to increase its production. That's the reason why countries are crazy about Gross Domestic Profit-GDP. (a measure of production).


  

How is a currency valued against another

 Who decides 60 Indian Rs is worth 1 USD. What factors do they consider to weigh currencies against each other. Why does it have to revalued after each passing day.These were some of the unexplored questions I had in mind. Whenever I try to look for an answer, I never found any which made me think this is something only an economist can comprehend but is certainly not.

Here is a simple story-like explanation on how a currency is valued against another.

Kay lives in Xioma, a small country bordered by the seas. Xioma prints its currency(Xs) in only one denomination that is 10. Kay takes home a daily wage of Xs.100 which is nothing but 10 Xiomic currency notes. One fine day, Kay, a chocolate lover, visits a chocolate shop that was newly opened in his neighborhood. There, a chocolate bar costs Xs.20, so Kay hands in two 10 currency notes to buy a bar of chocolate. The chocolate bought was of moderate quality but considered best in his locality.

Now, Kay learns about a new chocolate shop in a distant island nation that sells quality chocolates and decides to visit the store. There, Kay faces a problem, a single bar costs 500 and the store accepts 100 currency notes only. He did try to give the shop guy fifty 10 currency notes which the shop guy refused to take. Instead the shop guy asked for a five 100 currency notes for a bar of chocolate worth 500.

So Kay finds a guy David, who exchanges ten 10 currency notes for one 100 note. That way, by exchanging fifty 10 notes, Kay now has five 100 notes. The chocolate bought for 500 was too good that everyone from Kay's locality visited the shop and the shop's popularity grew eventually which means there is now a demand for 100 currency notes.

Everyone who want to buy the chocolate for 500 visited David first, as only he can exchange currency notes. Due to overgrowing popularity of the chocolate and demand for 100 currency notes, David now decides to exchange one 100 currency note for twelve 10 notes which in other words, a 100 currency note of the island nation is worth 120 Xiomic notes.

So now,

Did Kay lose money? No,
Did David gain money? No,
Did the value of Xiomia currency degrade? No
Did the cost of the chocolate increase? No

then, what has changed? the demand for 100 currency notes. 

A currency gets valued and devalued based on its demand and demand is monitored on daily basis. So when we say Rs.60 makes up $1, it means there is more demand for dollars.

Just by interchanging Chocolates with Crude Oil, Xiomia currency with INR, 100 currency note as single USD, one could pretty much understand  this currency valuation process at least at the top level given that it is even more complex.