If you’ve never left the family farm to travel to distant shores, then you may be unaware of the concept of currency exchange rates, or unsure of why such a concept is even necessary. Perhaps you lie at the opposite end of the spectrum and have vast globe-trotting experience, but have never quite understood why the guy in the Paris airport wants to sell you Euros in exchange for your dollars at a different rate than he wants to buy your Euros back from you when you’re heading home; after all, Euros are Euros and dollars are dollars, aren’t they? As you will see, that all depends on where you stand in the currency exchange business.
It’s pretty common knowledge that most countries have a central bank who issues their country’s currency, and it’s a natural and logical extension that each currency in the world has a certain value. Currency exchange rates exist in order to conceptualize the value of each of these discrete currencies in relation to each other. This relationship, which is expressed as an exchange rate (and is also known as a foreign exchange, or forex rate, or even as an FX rate) is extremely important, regardless of whether you’re a Mexican tourist trying to pay for pizza in Rome or a sovereign government trying to settle your debt with international lenders. Either way, you need to know that there is a common and accepted relative value between the currencies in question that allows you to agree on equivalent amounts expressed in each other’s currency.
Exchange rates have a different import for the casual traveler than they do for banks, sovereign governments or the forex trader. A visitor to the United States from Japan who arrives with Japanese yen in his pocket will need to exchange those yen into dollars in order to have spendable cash during his visit. Most likely, he will go into a bank or an American Express office or similar currency exchange provider and will have no choice but to pay the prevailing rate; this rate will be expressed as a decimal figure, such as today’s prevailing rate of 0.0128, meaning that our tourist will have to hand over 100 yen to receive roughly $1.28. When he returns to the money changer to sell back his dollars for yen, he will only receive 78.25 yen for each dollar he sells; the difference between the sell rate and the buy rate is simply the money changer’s commission, and is lost to the tourist.
The next time the tourist comes to America, however, he will surely pay a different rate each time he buys or sells dollars in exchange for his yen. This is true because both the dollar and the yen are quoted at a flexible, or floating, exchange rate. Exchange rates “float” between the currencies of developed, industrialized nations for a variety of reasons, both macroeconomic and microeconomic, and their movements are a reflection of the issuing countries’ perceived stability and strength and thus are fascinating to observe. Currencies with typically high values, such as the US dollar and the euro, are indicative of highly creditworthy issuing countries with mature and stable economies, whose values float against each other based on interest rates, debt levels and the like. Indeed, these major currencies are quoted against each other in pairs.
In contrast to the floating exchange rate system is the pegged exchange rate system, under which a currency’s value is artificially linked to an unrelated index, such as the price of gold, or even the US dollar; most typically, the use of pegged exchange rates is associated with centrally-planned economies, such as China, the former Soviet Union, and other communist or strictly controlled states. Pegged rates do not fluctuate and remain static until officially changed by the ruling government, as opposed to being determined by market forces and influences.
You may have heard the statistic that the foreign exchange market is the largest and most liquid market in the world. This is true, and is a reflection of the fact that international banks, governments and multinational corporations have a constant need to settle their debts and make payments in other countries’ currencies. On this more macroeconomic level, currency exchange rates differ greatly from those paid by our Japanese tourist, and the difference in rates charged can be understood as being analogous to the difference between wholesale and retail prices. Such wholesale foreign exchange players trade currencies at rates set by banks for their best customers, which are unattainable to the retail trader. As a matter of fact, the retail forex trader has no visibility into the prices being offered or charged by the major banks and rather is dependent on his FX dealer to quote currency prices to him, with no ability to know whether the dealer has inflated the prices he receives from his bank to any degree. It’s interesting to note that the most advantageous—and realistic, in terms of their reflection of a currency’s real value vis-à-vis another—foreign exchange rates utilized today are those used between governments to settle their mutual debts, via their corresponding central banks.
Now that you know what exchange rates are and how they work, you’ll need to know how to find them. Currency converters are easily accessible online, whether from search engines such as Google and Yahoo, whether from bank and brokerage house websites, or whether from foreign exchange dealer sites. Indeed, all major banks and brokerage houses have forex information available directly on their web pages, and many have conversion tools and widgets embedded in their online resources. Finding current exchange rate information is easy with today’s digital technology, and there’s no need to be surprised by fluctuations in the relationship between currencies in any given pair. Certainly, the modern investor interested in forex trading has no need to search for currency exchange rates in the newspaper, since by definition, by the time such rates are published, they are already obsolete: the forex market is not only the world’s largest, but also the world’s fastest-moving, and taking advantage of online tools is the most expedient way to ensure that you stay abreast of the latest currency movements.
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