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I have always read in present time currency exchange rate works on demand and supply

But imagine tomorrow a brand new nation with brand new currency is born

All its people are farmers and land is not that much fertile , so all they grow is to feed themselves, to world economy they can provide cheap labour but population is 1 million

Now they want to trade with other country, so how will they determine the currency exchange rate ?

Demand and supply will work afterwards but first we need to decide at which rate to peg this new currency to other worlds currency

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  • $\begingroup$ Nobody will accept their currency, they will have to use currency of another country for international trade. $\endgroup$
    – Naktibalda
    Oct 7, 2022 at 9:03
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    $\begingroup$ Does this answer your question? Who determines the exchange rate and how? $\endgroup$
    – Giskard
    Oct 7, 2022 at 9:21
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    $\begingroup$ @anuraagshukla yea just because country or someone wants something to happen it does not mean it’s realistic or possible. I would want to be able to grow wings and just fly to work instead of biking, yet alas that’s not possible. It’s not possible to develop highly developed exchange rates markets overnight, and it’s impossible for a subsistence farming society to have highly developed trade networks and exchange rate markets. $\endgroup$
    – 1muflon1 ♦
    Oct 7, 2022 at 11:57
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    $\begingroup$ If the price of food (in the new currency) has been established within the new country then people from other countries can see what value the currency has. So, assuming that foreigners have some desire to buy food from the new country then this will establish an exchange rate... though if the price of food has yet to be established within the new country then that's another question. $\endgroup$
    – Mick
    Oct 7, 2022 at 18:36
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    $\begingroup$ @mick so we can compare lets say 1kg price of tomato between two countries and get the exchange rate, yes this sounds good answer, this seems to be perfect answer $\endgroup$
    – anuraag shukla
    Oct 8, 2022 at 7:50

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There is an idea called the law of one price.

Assume they're making a durable, easily transported grain. Rice, maybe. Assume this is the only thing made in the entire world, because life is complicated and this abstract example is supposed to be simple. Call the local currency J's (because it's easy to reach on my keyboard).

Finally, assume rice is \$2/lb in the real world, 10J/lb locally.

Presumably, some rice-buying speculators should be willing to offer about \$2 to get 10J, roughly.

But, to make things more complicated, there are other practical questions:

  • How reliable is the supply chain to get rice from this country? What is the risk?
  • How about transportation costs? Rice rots, eventually, must be shipped dry, etc.
  • Are there other uses for J? When other goods are introduced, how do we deal with the fact that this direct average no longer is clear?

The comments are correct that in practice small countries tend to absorb the currency of larger countries, usually USD but even BTC has been used. The logistics of managing a stable currency are too difficult and require institutional strength and a great deal of reputation. Few investors are interested in buying into something that that might go up in smoke.

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