The exchange rate is the price of one currency expressed in another. So when we read that the exchange rate of the euro against the dollar (€ / $) is 1.10 euro means that a dollar can buy 1.10. We can also express the exchange rate in reverse, ie, dollar / euro ($ / €), which in this case would be 0.91, ie, a dollar can buy 0.91 euro.
EXCHANGE MARKET
The market exchange rate of one currency against another varies according to the law of supply and demand. There are two possibilities: that a currency appreciates relative to each other or to depreciate.
Appreciation. When a currency (as a commodity) is low rises in price (it can be seen) or because it is in high demand or because there is little compared to other currencies. If for example, an operation increases the quantity supplied of dollars, the exchange rate of the dollar against the euro ($ / €) decreases, because to buy one US dollar it takes less euro. Or what is the same, the exchange rate of the euro against the dollar increases, because with a euro can buy more dollars.
Depreciation. Currencies depreciate when abundant because there is an oversupply of them or because they are abundant in relation to the limited supply of other currencies. If, for example, have an operation that increases the quantity demanded of dollars, the exchange rate of the dollar against the euro ($ / €) increases, because to buy one US dollar it takes more euros. The same applies when the amount supplied of euro.
CURRENCY DEMAND IN THE INTERNATIONAL MARKET
The main reasons why some countries demand more or less foreign currency are:
- Exports or imports of goods and services. It is the exporter who sets the currency in which an international transaction, usually his own or the US dollar is done. For example, the countries of the euro zone, Spain included, require payment in euro when they act as exporters. Consequently, buyers will demand euros in the foreign exchange market for the payment, which will cause an increase in the exchange rate of the euro against other currencies. When you import just the opposite happens and the exchange rate fall relative to the currency that is claimed to import.
- The inflation rate. If inflation rises one country and the other not, prices increase and exports decrease, resulting in lower demand for the currency of the country concerned. In contrast, imports will be higher, as it will be cheaper to buy in other countries than their own. As you have to offer to buy the national currency, lower its exchange rate relative to the currencies demand.
- The interest rate. The price of money is always associated with a currency. If you increase the interest rate that financial intermediaries pay on deposits in a given currency, that currency will be more attractive in the eyes of foreign investors, which will increase demand so that increases the value and therefore reduces its type change.
- Forecasts of appreciation and depreciation. Future expectations also influence the exchange rate. If a currency tends to depreciate or economic prospects are not good, operators will want to change it before depreciate, ofertándola on the market in exchange for other stronger currencies.
- The performance of the monetary authorities. Central banks may intervene by buying or selling their currency to avoid sharp fluctuations in exchange rates.
convertibility and exchange costs: In addition, to acquire foreign currency converter two issues should be considered.
- Convertibility is the ability of a currency to become another. It turns out that only certain currencies are convertible, also with some restrictions. Due to this reason many exporters set the price of the operation in strong currencies like the US dollar or the euro, although they are not national.
- Financial intermediaries operating in the currency markets charge a percentage or commission for currency exchange. Thus, the costs of imported goods must be added that exchange. And they are not negligible expenses, to the extent that save them was one of the major reasons for the monetary union of the EU. And in 1988 it was estimated that the elimination of currency exchange rates between the twelve countries that then formed the EU would save between 15,000 and 20,000 million euros annually.
EXCHANGE SYSTEMS
The three main exchange rate systems are flexible exchange rates, the fixed exchange rate systems and mixed or semi-fixed exchange rate.
Flexible exchange rates
Its main feature is that the monetary authority does not intervene. The price of the currency is determined by the free play of supply and demand in the currency market.
Fixed exchange rates
In a system of fixed exchange rates the central bank rigidly determines the exchange rate outside the play of supply and demand of foreign exchange trading. The value of one currency in terms of another it is called parity exchange rate.
In a fixed rate system changes rather than talk about revaluation it is said and appreciation rather than depreciation is called devaluation.
When a devaluation occurs, domestic products are cheaper for foreigners, thereby growing domestic exports. Meanwhile, foreign products are more expensive thus decreasing imports. In the case of revaluation, the opposite happens.