Exchange rates

There are all kinds of different kinds of money in this world, different types of money for different people.

So it sometimes comes to pass that we need to trade some of our money for money from a different country. So how much of one kind of money do you get for another? And how is it all decided?

Let's find out.

A buck of a different color

All people need some type of money to help buy the things they want.

But different people have different forms of money that work for them. Here are some examples:

You can find a more complete list here. But the point is this. If one is going from one country to another, you need to exchange some of your money for that other country's money.

But how much of the new country's money would your money trade for? For example, suppose you are going from the United States to Albania, and you wanted to trade in $100 for some Lek (the money of Albania), how many Leks would you get?

Exchange rates tell you how much you get. At the time of writing, each dollar gets Lek 105.3, so the $100 in the above example would trade for Lek 10,530.

The big question then is how do they decide how many Lek would you get to the dollar?

This has a long history.

The way things were

What is money, really? The money in your wallet, purse, or your mattress is just paper; the money for a debit card is only numbers on a computer.

Up to about a century ago, what made money valuable is that it could be traded in for gold or silver. This meant that carrying money was like carrying a little gold or silver around with you.

Of course, not all countries used the same amount of gold or silver for their money – so not all forms of money had the same real value. Some were worth more than others. So when changing your wad of cash for that of another nation, you would need to get different amounts to keep the same value.

For example, country A's dollar is worth a pound of gold (a ridiculous amount, I know, but be patient), with county B's dollar backed by two pounds. So if a person in B traded one of their dollars for one of country A's, they would get a dollar that is half as valuable (one pound as compared with his original 2 pounds). This person must insist on getting 2 of country A's dollars for his original to keep from losing value.

Take another, real example. For a long time, the US dollar was more valuable than the British Pound so, in changing a dollar for a pound, you needed more pounds to give the same value. If a person in 1900 wanted to trade $100 for pounds, they would need to receive nearly 500 pounds.

This is called the Gold Standard.

But in the early 1900s, this proved too restrictive for progressive governments. So, by the 1930s, nations went off the gold standard.

A new system was needed.

To market to market

Different schemes were tried but, in the 1970s, nations agreed on the current way of doing things.

Now money is exchanged by banks in a big world-wide market.

OK, it isn't a physical place like a farmers market, but now money is traded between banks, and the need to "buy" a country's bucks changes how valuable it is. The more Russian Rubles people want, the more it is worth – you would get more Mexican Pesos (for example) for a single Ruble.

And on it goes.

OK, it is all a bit complicated and confusing.

Welcome to the world of finance.

On the web

How Does Forex Work?

This short video explains how the exchange of foreign money (the Forex) works and how traders use it to make money.

XE Currency Converter

This site allows you to look up exchange rates for all different currents as they are in real-time.

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