I am writing this from New York, New York and after several passes at that sentence, I still don’t know how to make it not sound pretentious. No matter, I’ve decided the best course of action is to lean in so I am currently sitting in a miniature library in Brooklyn, sipping an americano, and listening to what I can only refer to as “Thanksgiving music”. Think happy jazz? The man next to me is wearing tiny glasses and a knit sweater, so I am certain he’s writing the next great American novel.
On my flight over I did what any proper New York enthusiast would do – read essays, re-watched the Netflix special, and attempted to mentally vibe-match the quintessential curmudgeonly New Yorker herself – Fran Lebowitz.
Much of her work is an unconventional love letter to the city; like the boy who throws his crush’s lunchbox into the bushes at recess.
“There is no place harder to live in than New York. Not one thing in New York isn’t a problem. If you want to go into a store and buy some fruit, there is going to be some sort of opera. When you leave New York and stay in another place for some time, you think it’s a dream! You can just go into a store and buy some grapes and it is not going to end in a huge fight. But, obviously, I made the decision numerous times that, although it is easier [elsewhere], I just don’t care [to live anywhere else].”
And on people…“To hone your personality into some incredible drama is a favorite past time of New Yorkers. Even people who seem very ordinary, if you watch them for two seconds, they are going to do something that makes you think ‘what?'”
For some elusive reason, I find this all quite romantic. A cab driver screaming, the smell of urine in the subway, the thick accents of street vendors, the disconcerting levels of patriotism, the never-ending performance of it all – to just exist and survive here makes you feel extraordinary. New York is almost perfect. Unless of course, you’re a Canadian and are getting metaphorically assailed by the exchange rate.
($15 coffee will never feel trendy).
So, without any further romantic proclamation, here are the what’s the how’s and the why’s of exchange rates.
What Is an Exchange Rate?
We’re starting out easy (after all, I am sort of on vacation). This felt like something I should know the answer to but found I couldn’t articulate properly, so here it is for anyone else feeling dim today:
An exchange rate is a rate at which one currency will be exchanged for another currency.
For example, in July 2022, the exchange rate from U.S. Dollars to the Euro was 1.02, meaning it takes $1.02 to buy €1.
Some of the Basic Things You Should Really Know.
- Most exchange rates are defined as floating and will rise or fall based on the supply and demand in the market.
- Some exchange rates are pegged, or fixed, to the value of a specific country’s currency.
- Exchange rate changes affect businesses by changing the cost of supplies that are purchased from a different country, and by changing the demand for their products from overseas customers.
Understanding Exchange Rates
The exchange rate between two currencies is determined by a slew of different mind-numbing factors such as economic activity, market interest rates, gross domestic product, and unemployment rate in each of the countries.
Commonly called market exchange rates, they are set in the global financial marketplace, where banks and other financial institutions trade currencies around the clock based on these factors.
Changes in rates can occur hourly or daily, with small changes or large incremental shifts.
When you walk into your bank (a thing I’ve recently come to realize I hate doing), the unnervingly happy teller will quote you exchange rates with a bunch of fun acronyms.
The acronym USD represents the U.S. dollar.
The acronym EUR represents the Euro.
The acronym for the currency pair would be EUR/USD.
Very straightforward.
How Exchange Rates Fluctuate Part 1: Fixed vs. Floating
This gets boring so I’m going to try to use a metaphor that probably won’t quite fit.
You are in New York and want to do the painfully cliché thing of pretending to be Audrey Hepburn and buy something from Tiffany’s. You choose to purchase a chunky charm bracelet – these are in again, FYI. The flawless woman working at Tiffany’s takes one look at your battered New Balance shoes and lets you know you can pay in installments. It’s subtle; nice of her.
She explains that you can either pay a fixed or floating amount monthly for the bracelet.
The floating option will fluctuate due to changes in the foreign exchange market (right on cue, my metaphor has fallen apart).
The fixed rate is pegged to the value of another currency which just means if something crazy happens in the foreign exchange market you won’t be having to sell a kidney to afford your new charm bracelet.
Example: The Hong Kong dollar is pegged to the U.S. dollar in a range of 7.75 to 7.85. This means the value of the Hong Kong dollar to the U.S. dollar will remain within this range.
How Exchange Rates Fluctuate Part 2: Spot Rate vs. Forward Value
I’m over it with the metaphors.
A spot rate or price, which is also known as cash value, is just the current market value of a given currency.
A forward value is based on the expectations for a currency to rise or fall versus its spot price.
If traders speculate that the eurozone will ease monetary policy versus the U.S., they may buy the dollar versus the euro, resulting in a downward trend in the value of the euro.
I Want to Party in Berlin.
You want to try to get into the infamous Berghain and dance in a strange warehouse for 48 hours. You want 200 USD worth of EUR for this endeavour (always better to have a little extra).
- The sell rate is the rate at which you sell your USD for EUR.
- The buy rate is the rate at which one buys foreign currency back (USD) from travelers to exchange it for local currency (EUR).
If the current exchange rate is 1.05, $200 will net €190.48 in return.
$200 ÷ 1.05 = €190.48
After the trip, suppose €66 is remaining. If the exchange rate has dropped to 1.02, the change from euros to dollars will be $67.32.
€66 x 1.02 = $67.32
How Do Exchange Rates Affect the Supply and Demand of Goods?
Changes in exchange rates affect businesses by changing the cost of supplies that are purchased from a different country, and by changing the demand for their products from overseas customers.
What Is the FOREX?
The forex market (AKA the foreign exchange market) allows banks, funds, and individuals to buy, sell, or exchange currencies. The market operates 24 hours, 5.5 days a week, and is responsible for trillions of dollars in daily trading activity as traders look to profit by betting that a currency’s value will either appreciate or depreciate against another currency.
If you ask me (who knows nothing so you really shouldn’t be asking me), just stick to stocks.
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Until the next. And in the meantime, I’ll be enjoying my Canadian dollar being worth 74 cents.