The economics of currency exchange rate has also been rather elusive to me and I have never been able to fully understand how it works. Why do exchange rates fluctuate and what does it mean when one currency is weaker/stronger than another and how does that affect the currency that I am using? People often talk about losing money or getting more money when they exchange currency but what does that mean exactly? For example, looking current at the USD/GBP exchange rate. *1 GBP = 1.126 USD.* If I exchange £ to dollars, am I getting more money or losing money? Which one is stronger? Wouldn’t *1.126 USD not simply be of equivalent value to £*
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The forex market.
Imagine the stock market, except instead of trading parts of a company, you’re trading confidence in a country’s currency.
> For example, looking current at the USD/GBP exchange rate. 1 GBP = 1.126 USD.
Assuming equal inflation, that example says that GBP is worth more than USD, as 1 “dollar” of GBP is worth more than 1 dollar of USD.
As for why currency rates differ, that’s another topic, dealing with confidence in that country’s economic standing and whatnot.
Think of currency as cars. A car can drive you from point A to point B, so any car that can do that should be the same… not exactly.
You could have a Chevrolet Sonic or a Chevrolet Corvette, but still cars, both still get from A to B, but clearly they are not the same. Currency works similarly.
The two cars have different sized engines Countries have more/less powerful economies. The power of the car is based on horsepower and torque. The power of the country is based on the goods produced there. If your country has goods that the rest of the world wants, you generally have a stronger economy, money is constantly flowing in.
Back to your exchange rate, you take your $20k Chevy Sonic and put a briefcase with $70k in the back seat and now it’s “closer” in value to the corvette. Again both are cars, both get from A to B, but one has more value.
Suppose I want to buy something in the US…I need to US dollars to do that (mostly…there’s a few weird exceptions but those aren’t important right now). If I’m in, say Great Britain all I have is pounds, so I need to buy some US dollars. I do that on a “currency exchange”, a place where currencies are bought and sold.
Like anything else that’s being bought and sold, there’s people willing to sell (supply) and people who want to buy (demand). If those are roughly lined up, the price (exchance rate) stays about stable. But if a whole bunch of people in the UK want to buy US stuff, and hence need US dollars, then the people selling US dollars will ask for more of their pounds in exchange (because they can), and the price of US dollars *relative to pounds* will go up. This is exactly how the stock market, or the housing market, or any other market works.
The current exchange rate is just the last “price” (exchange rate) that anybody tranded US dollars for pounds.
Exchange rates fluctuate because people want different currencies at different times for different reasons. Before the Russia-Ukraine war, if you wanted to do business in Russia you needed rubles and so there was an exchange rate where you could buy rubles with pounds. Now that there’s a war and 1) nobody wants to do business in Russia so nobody wants to buy rubles and 2) people with rubles don’t want them because nobody wants to buy them so they’re desperate to sell them, even at a loss, and get some other currency that people might actually want. And, like any situation with oversupply and no demand, the price tanks and rubles become nearly worthless.
“Getting stronger” or “weaker” or “losing money in forex” are only caused by *changes* in the exchange rates. The absolute values don’t mean anything. The exchange rate between USD and Vietnamese Dong is something like 1:25,000 right now, just because the dong happens to be a very small unit relative to a dollar. But if I use $1 USD to buy 25,000 VND, then the exchage rate changes to 1:20,000 (the Dong got stronger), I can use my 25,000 VND to now buy $1.25 USD…I made $0.25.
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