The bearing of daily foreign exchange rates impact deeply upon millions of people and corporations in a variety of different ways. Foreign exchange rates simply measure the strength of one currency against another, and inform us how many units of one currency are required to buy a different unit of currency.
How Foreign Exchange Rates Affect People & Companies
In this article we delve into the intricacies of how rate changes affect people, companies and even governments. We’ll look at how rates are interpreted and discuss their importance in globalization.
Reading Foreign Exchange Rates – When we read that the UK Pound vs the US Dollar rate is 1.6, it means that for every one Pound, we get 1.6 Dollars back. The Pound is therefore stronger than the US Dollar. If one month from now, the UK Pound v Dollar rate has changed to 1.55, something has happened to make the Dollar strengthen against the Pound. Foreign exchange rates fluctuate daily – in fact they change fluidly almost by the second, so the rate you see today can be markedly different to the one you will see tomorrow.
Foreign Exchange Rates Have The Power To Make Your Holidays Cheaper (Or More Expensive) – As you might imagine, one of the most powerful stakeholders within the foreign exchange world are travellers. When we go abroad for business or pleasure, we need to buy local currency in order to purchase goods and services in that country. Without the foreign exchange market this would not be possible. The way in which foreign exchange rates are set have a powerful impact on travellers – keeping with the US Dollar and UK Pound example above, if a British family wanted to travel to the USA, their purchasing power would be directly impacted by rate movements. So, when the Dollar strengthened against the Pound to 1.55 above, the family’s purchasing power would be diminished by that move. Let’s say the family had £2,000 spending money for their vacation – had they bought their holiday money when the rate was 1.6, they would have gotten $3,200. Since they were only able to lock in a rate of 1.55 as it turns out, they would only be visiting America with $3,100 – a whole hundred bucks less.
Rate Change Impacts On Business – Rate changes affect many more groups than holidaymakers. Business profits are often at the mercy of rate changes too. Companies can have a direct interest in rate changes for a multitude of reasons. For a start, if they export their goods, the rates will have a huge bearing upon how competitive they can be. Additionally, many British companies outsource their services, and buy raw goods and materials from abroad. The strength of the UK Pound will be incredibly important to them, in determining how much they actually pay for these imported goods. In order to mitigate currency fluctuations, many companies engage in a process that is known as “hedging“, where they hold currency positions that are directly polar to the net currency positions that they do business in. Finally, it’s worth noting that in many instances, companies that face adverse rate changes will simply pass on the cost to the consumer – another way in which the rates impact ordinary folk like you and I.
The demand for currency exchange, and the importance of rates has increased exponentially with the onset of globalization. Currency rates are simply not in the control of any one party – this is one of the many reasons that private traders like wheeling and dealing in the forex. There is simply less scope for any one market maker to play devious games. However, governments who have control of their own central banks can and do manipulate the strength of their own currency. They can increase or lower their base rates, thereby making the economy more or less attractive to foreign investment. Often during deep, cutting recessions, a government may opt to slice rates to the bone to help its domestic citizens. Lower rates mean lower mortgages and lower interest on loans for people and businesses. In contrast, a government may opt to raise interest rates during high inflationary periods.
The bottom line is that currency rates are highly fluid and affect just about every man woman and child in our world.