[ELI5] Why is the exchange rate between two currencies not the same going both ways? Like why is the exchange rate of USD to GBP different from GBP to USD

In: Economics

If the exchange rate is the same the US to GBP rate will be 1/(GBP to USD) rate. The rate in both directions is only identical if the value of the currency is identical in valure with a exchange rate of 1.

If there is 2 GBP for 1 USD then the GPB-> USD rate is 2.0 and the USD-> GBP rate is 0.5

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If you that inverse relationship was included it is the case that the rate include what the exchanger takes for them selfe to run the company. So they take away a percentage as a fee to run the operation and to make profit.

You could have written it an exchange rate of X with a fee of 1% but that is harder for a consumer.

It’s like any unit conversion. You get from miles to kilometers you multiply by 1.609, and to get from kilometers to miles you multiply by the inverse which is 0.622.

The difference between units and currency is that the currency is often based on the ratio of a unit of the desired currency. They have charts for how many dollars it takes to buy one (1) GBP, Euro, Lira, etc.

It is the same otherwise it could be arbitraged. The spread you’d be seeing is what the buyer/seller of those currencies is charging i.e. when you convert your GBP to USD, the converter takes a fee.

Currently my screen is saying 1 GBP buys 1.2325 USD and the other way is 0.8112. Taking the inverse of 0.8112 you get 1.2327 – really close with the cost of exchanging being roughly 2 basis points.

Another thing to note is that there is no formal market structure for FX as there is with equities and some commodities. FX deals are done on a party to party basis and are a bit more opaque.

You didn’t explain the context so there might be different explanations:

1) If you are in a bank or at a money changer, then the spread accounts for their expenses and profit. Say the “true” exchange rate is 1 GBP : 2 USD. If you have 1 GBP, the bank or exchange will probably only give you something like 1.95 USD – that 0.05 difference is their charge for the service. If you have 2 USD, you will get less than 1GBP – again for the same reasons.

2) In a Forex market, (and most markets of this type) the market will have an open order book. This will have the list of offers to buy from different people and a list of orders to sell again from different people. If the offer to buy matches the offer to sell (ie they agree on a price) then the exchange occurs. Naturally this happens very fast so what is mostly seen is the “gap” between the current open orders aka as the “bid ask” spread. This represents (for that instant in time) the lowest price someone is willing to sell and the highest price someone is willing to buy.

If a dollar was worth 0.5 pesos, the peso is worth half as much as a dollar. If 0.5 pesos was worth one dollar, the dollar is worth double the peso