The exchange rate is the price in a foreign currency that must be paid to get a unit of the national currency.
By The Forex Review - 26 / April / 22 458
Dominick Bell
The exchange rate.
The exchange rate is the price of one currency expressed in another currency. For example, the euro-dollar exchange rate is the amount of dollars received for one euro: if we say that the euro-dollar exchange rate is 1.25, it means that you need to pay $1.25 for the purchase of one euro. The foreign exchange market is a market where currencies (we are talking about currencies) are exchanged for each other, and currency exchange is precisely the operation of converting one currency into another. As in all markets, the price (exchange rate here) is determined by the confrontation between supply and demand (currency here). A currency is called convertible if it can be freely exchanged on the foreign exchange market. The confrontation of supply and demand for a currency in the foreign exchange market leads to an increase or decrease in its exchange rate against other currencies. For example, if the demand for Euros increases, the value of euros in other currencies increases. And, conversely, if the demand for the Euro decreases or the supply increases. Where does the supply and demand of the currency come from ? If a French importer has to settle with his American supplier in dollars, he will seek to buy dollars, paying for them with his euros, then there is a supply of euros and a demand for dollars. Conversely, a French shareholder of an American company selling his shares will seek to get rid of dollars in order to get euros that he can use at home. : then there will be a supply of dollars and a demand for Euros.
A currency is considered floating if the currency authorities allow exchange rates to fluctuate depending on fluctuations in the supply and demand of private agents. On the other hand, if they enter into agreements among themselves requiring them to maintain exchange rates at the level they have chosen, then the exchange rates are called fixed. However, even with a floating currency, for example, the European Central Bank (ECB) and the US Federal Reserve (Fed) can agree to stabilize the euro-dollar exchange rate: if the value of the euro rises against the dollar, the ECB creates euros, which it sells to buy dollars, which increases the value of the latter; and if the dollar growing, the Fed can create dollars with which it will buy euros. But this is just an accident, not an obligation.
Goals.
The main role of the exchange rate is to allow international settlements related to international trade: the exporter does not want to receive payment in foreign currency because he needs the national currency to pay his employees or suppliers, while the importer a priori has only his own currency to pay. Thus, every time an international trade operation takes place, a currency operation will be carried out.
Changes in the exchange rate will affect the prices of export goods. If, for example, a product manufactured in France and sold in the USA costs 100 euros at an exchange rate of 1.25 dollars per euro, then it will cost US consumers 125 dollars (100 x 1.25 dollars). A decrease in the exchange rate to $ 1.10 per euro will lead to a drop in the export price to $ 110 (100 x 1.10), while an increase in the exchange rate will lead to its growth. Symmetrically, a product manufactured in the USA sold in France worth 100 US dollars will cost French consumers 80 euros (100/1,25) in the first case and 90.91 euros (100/1,10) in the second case. Thus, any decrease in the exchange rate of the national currency favors exports and adversely affects imports, and vice versa, contributes to an increase in the exchange rate. Thus, a country has the opportunity to improve the balance of its foreign trade (and, consequently, its growth) if it reduces the value of its currency. Countries that consistently undervalue their currency to facilitate their exports are accused of conducting monetary protectionism.
It is in order to avoid this form of protectionism that countries sometimes agree to a system of fixed exchange rates – for example, the Bretton Woods System (1944-1971) or the European monetary system (1979-1992). But some economists point out that a flexible currency system helps balance trade. The reasoning is based on how the foreign exchange market works. If a country has a current account deficit, it means that the country does not have enough currency to pay for purchases in the rest of the world ; therefore, he must request them in the foreign exchange market, which reduces the value of his currency compared to other currencies. As a result, the exchange rate of the national currency decreases, which promotes exports and restricts imports, which ultimately leads to a rebalancing of foreign trade. The mechanism is reversed in case of excess of current payments.
However, this idea that exchange rate fluctuations by themselves can balance foreign trade has been sharply criticized, if only because the movement of exchange rates depends not only on international trade settlements, and as a result, the external deficit may be accompanied by an increase in foreign trade. The exchange rate is the same as in the case of the United States in the 1980s or in the late 1990s.
Indicators.
In the economic literature, you will find the value of bilateral exchange rates, that is, the exchange rates as they were defined above, for example, as the exchange rate of the euro to the dollar, the pound sterling to the yen, etc. However, be careful, the values given may be one-time (for example, the dollar exchange rate at the end of the day) or be average for a certain period (the tables in the "trends" section are presented in monthly averages). In the latter case, the volatility of the exchange rate will be less, since the average value will "smooth out" the fluctuations of the period. You can also find multilateral exchange rates. In fact, this is the index of the bilateral exchange rate, that is, the weighted average value of the value of the currency expressed in different foreign currencies. For example, the first table in the "trends" section represents the change in the exchange rate of the dollar against the 10 currencies of the G10 countries.
There are two ways to quote exchange rates: definite and indefinite. In the first case, the exchange rate gives the value of the national currency in a foreign currency, for example, 1 euro = 1.15 US dollars. In another case, the value of the foreign currency in the national currency is indicated, for example, 1 US dollar = 0.90 euros. Traditionally, currency quotes are currently given to certain, but before the introduction of the euro in France there was a tradition to show quotes to uncertain. Of course, any of the quotes come back to the same thing, you just shouldn't make mistakes if you make a calculation!
Trends.
While the Bretton Woods fixed currency system (1944-1971) made it possible to significantly limit fluctuations in exchange rates, the floating currency system that replaced it contributed to the return of instability in the foreign exchange market. An example of this is the volatility of the value of the dollar, which has been the dominant currency in international trade since 1945. The European Union decided to reduce exchange rate fluctuations between its members, because their trade is very intensive, and they wanted to avoid the development of monetary protectionism, which would disrupt the single market project. This is the beginning of the European monetary system (1979-1992), which will be replaced by a single currency. The entry into force of the euro has led to the fact that exchange rates between European countries have been completely abolished, since they now use the same currency. However, although the euro is equivalent to the full stability of exchange rates within Europe, the external exchange rate of the euro, that is, with other world currencies, also turns out to be very unstable, especially due to the lack of governance. from the external value of the euro. Indeed, the European Central Bank (ECB) deals only with inflation, and the Council of Eurozone Finance Ministers (Ecofin) is struggling to develop a clear policy, given the differences within it.
Frequent Mistakes.
Be sure that it is very difficult to understand exchange rates! The exchange rate is simply the price that is set in the market in about the same way as the price of strawberries.
Associate words like stock market, stocks, stock prices, etc. with "exchange rate" with "exchange rate". Then there is confusion between the financial market and the foreign exchange market.
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