Foreign Currency Exchange Rates Currency Is Fiat

¶ … Foreign Currency Exchange Rates

Currency is fiat money -- it's a coin or bank note that has value because the government says it does and as such becomes legal tender -- one is required to accept it to fulfill a debt. When the issue of currency leaves domestic grounds and becomes an issue of foreign exchange, things become really complicated. If a company wants to buy goods or services from someone else in a different country, they have to figure out how to pay for those goods or services. Since all currencies were not created equal this becomes a challenge and is the foundation of the most intricate market in the world -- the Foreign Exchange, where currencies are bought and sold based on continuously fluctuating values or exchange rates.

The exchange rates of currency make the world go round. Exchange rates affect the costs of imported and exported goods and services, and hence, the profitability of all kinds of different businesses. If a country's currency is strong, that means the citizens of that country have a high standard of living -- they can travel to other countries, buy imports, etc. But that also means the product of that country is expensive for other countries, so they cannot export as much. If a country's currency is weak, that means the people living there have a low standard of living -- foreign travel is difficult, as is affording foreign imports. However, their products are really cheap for everyone else so they can sell a lot.

The exchange rate is the price of one country's currency expressed in another country's currency. For example, as of 12:42 EST on 21 September 2011, one euro was determined to be equivalent to one dollar and thirty-seven cents, give or take a few tenths of a penny. In the short-term, this rate is determined by investors buying and selling currencies on a minute by minute basis. This is currency trading, much like the stock market. A country needs to have a supply of all the different types of currency it may want to do business in, but some currencies are very unstable so it is not a great idea to keep them for long. Another reason people buy and sell currency is because they predict a currency will go up in value and they buy it when it is low so they can sell it again when it goes up. So the value of the currency is based on the perceptions of the people buying and selling it -- in the short-term. In the long-term, a currency is valued higher when countries bring in more money than they spend, and valued lower when countries spend more money than they bring in.