Economists agree free trade is best, but not on how to set exchange rates
Economists broadly treat free trade as the ideal, yet they have no consensus on the best way to manage a currency's value. Floating, pegged or something in between, each country's choice ultimately reflects politics. Meanwhile banks trade about $5.3 trillion of currency between themselves every single day.
An exchange rate is simply the price of one currency in terms of another. If a dollar buys 141 yen, then a yen costs one 141st of a dollar. Currencies are usually national, but Hong Kong's is sub-national and the euro spans many countries. Under a floating regime the rate is set in the foreign exchange market, which trades continuously from Sunday evening to Friday night, Greenwich time. The spot rate is today's price; a forward rate is agreed now for delivery on a set future date.
Travellers pay more than that wholesale price. Banks, brokers and bureaux de change buy currency on the interbank market, the Bank for International Settlements' $5.3 trillion-a-day figure, then resell it with a margin or commission, often hidden inside a less favourable rate. The gap between what a dealer pays and charges is the bid–ask spread. Cash may be priced differently from electronic transfers, since banknotes must be stored, guarded, shipped and paid for up front. Individuals speculating through online platforms made up about 5.5 percent of the market in 2016, some $282 billion a day.
Quoting conventions trip people up. In a pair such as euro to Australian dollar, the first is the fixed unit and the rate shows how many of the second it buys. When neither currency has priority, traders pick the base that yields a number above 1, which avoids long strings of decimals, although Japanese quoters often put the yen first. In the UK retail market the pound is quoted as the base against the euro.
Most countries use direct quotation, pricing a foreign unit in home currency, such as €0.8989 per dollar in the eurozone. British newspapers, along with Australia, New Zealand and the eurozone, often use indirect quotation instead, such as $1.11 per euro. The two move in opposite directions: under direct quotation, a falling number means the home currency has strengthened.
Source: Exchange rate
