How Do Currency Rates Affect the Markets?

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About Exchange Rates

A currency exchange rate is the rate, or ratio, at which one world currency can be exchanged for another. For instance, the United States dollar might have an exchange rate of 1.5:1 to the euro, meaning it would take one dollar and fifty cents to buy one euro. Exchange rates are determined by a wide variety of factors, but at their core they are determined by the supply and demand of a given currency. The more people that want to hold U.S. dollars, the more that dollars will be worth. On the other hand, the more that U.S. dollars the Treasury decides to print, the less each dollar will be worth, because there will be more of them to go around. Higher real interest rates in a country (interest rates minus inflation) tend to increase a currency's value, because international savers will demand the currency in order to save at the high interest rates.

International Trade

Perhaps the most important aspect of currency exchange rates is in international trading markets. Exchange rates have a direct impact on how many goods a country can import or export from another country. For instance, when the U.S. dollar is doing well, Americans demand more goods from abroad, because the dollar is able to buy more foreign currency and therefore more goods. When the U.S. dollar has bad exchange rates, foreign goods become relatively more expense, which reduces imports and causes U.S. citizens to buy more from domestic producers. On the other hand, when the dollar is doing poorly, it makes goods produced in the United States relatively cheap for other countries to buy, which in turn increases demand for U.S. goods and raises U.S. exports. In general, consumers benefit from a stronger dollar because they can buy more goods abroad, while producers often benefit from a weaker dollar since more customers abroad will demand their goods.

Travel

Currency exchange rates have a large impact on the market for international travel and tourism. When you travel to a foreign country, you must buy that country's currency in order to use at restaurants, hotels, and other attractions. When the dollar is strong, you can buy a lot of that country's currency, which will make traveling there cheaper. If the U.S. dollar is weak versus the currency of a particular country, you might avoid traveling there and go to a different country that does not have such a strong currency. Similarly, a weak U.S. dollar will attract more travelers to the United States, since domestic prices will be relatively cheaper to other countries.

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