Maybe you've traveled to Mexico or Canada, and exchanged your American dollars for pesos or Canadian dollars. Or, perhaps you've traveled from England to Japan and exchanged your English pounds for yen. If so, you have experienced exchange rates in action. But, do you understand how they work?
You've probably heard the financial reporter on the nightly news say something like, "The dollar fell against the yen today." But, do you know what that means?
In this article, we'll tell you what
exchange rates are and explain some of the factors that can affect the value of currency in countries around the world.
The Cost of Money:
National currencies are vitally important to the way modern economies operate. They allow us to consistently express the value of an item across borders of countries, oceans, and cultures. We need exchange rates because one nation's currency is not always accepted in another. You can't walk into a store in Japan and buy a loaf of bread with Swiss francs.
First, you'd have to go to a bank and buy some Japanese yen with your Swiss francs. An exchange rate is simply the cost of one form of currency in another form of currency. In other words, if you exchange 1 Swiss franc for 80 Japanese yen, you really just purchased a different form of money.
The Floating Exchange Rate:
There are two main systems used to determine a currency's exchange rate: floating currency and pegged currency.
The market determines a floating exchange rate. In other words, a currency is worth whatever buyers are willing to pay for it. This is determined by supply and demand, which is in turn driven by foreign investment, import/export ratios, inflation, and a host of other economic factors.
The Pegged Exchange Rate:
A pegged, or fixed system, is one in which the exchange rate is set and artificially maintained by the government. The rate will be pegged to some other country's dollar, usually the U.S. dollar. The rate will not fluctuate from day to day.
A government has to work to keep their pegged rate stable. Their national bank must hold large reserves of foreign currency to mitigate changes in supply and demand.
Elimination of exchange-rate fluctuations - The euro eliminates the fluctuations of currency values across certain borders.
Transaction costs - Tourists and others who cross several borders during the course of a trip had to exchange their money as they entered each new country. The costs of all of these exchanges added up significantly. With the euro, no exchanges are necessary within the Euroland countries. you can exchnage currency with the best
money changer app.
Increased trade across borders - The price transparency, elimination of exchange-rate fluctuations, and the elimination of exchange-transaction costs all contribute to an increase in trade across borders of all the Euroland countries.
Increased cross-border employment - With a single currency, it is less cumbersome for people to cross into the next country to work, because their salary is paid in the same currency they use in their own country.
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