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Got a Yen...To Learn About Foreign Exchange?

Source: FDIC Consumer News, Spring 1995.

The value of the U.S. dollar has an impact on all our lives, not just those of us who travel abroad. So what does it mean when the dollar is “up” against the French franc or “down” against the Japanese yen? Is it better to have a “strong” or a “weak” dollar? Who determines the value of the dollar versus foreign currencies?

Economic conditions in the U.S. play a big role in why the dollar fluctuates in value. An example: Large trade deficits mean dollars are flooding the world markets, causing a greater supply than demand, which creates a weak dollar. And if foreign investors think U.S. interest rates are heading down, they'll put more money outside the U.S. looking for higher rates, which lessens the demand for dollars and weakens the dollar's value.

When the dollar is weak—or down—against a foreign currency, that means it takes more dollars to buy the same amount of foreign money, and items you buy while abroad will cost you more. When the dollar is strong—or up—against a foreign currency, that means it takes fewer dollars to buy the same amount of foreign money, and items you buy while abroad will cost you less (or as many like to look at it, you can buy more stuff).

Let's say you're planning a trip to England and you're told a cab ride from the airport to your hotel in London costs 25 British pounds. If it takes $1.50 to buy one British pound, that cab fare will cost the equivalent of about $37.50 ($1.50 × 25). If at the time of your trip the dollar has weakened, however, it might take $1.75 to equal one British pound. That same 25 pound cab ride would end up costing you about $6.25 more ($1.75 × 25 = $43.75). Likewise, if the dollar gets stronger, that cab ride might cost you only $1.25 per British pound, or $31.25 ($1.25 × 25 = $31.25).

This same principle applies to anything else you might buy—souvenirs, food and so on—while you're away.

Many people planning a trip try to predict what a foreign currency will be worth in the future. If they think the dollar will be strong they may hold off converting their dollars until right before they depart. Or if they think the dollar will be weaker, they may convert their dollars several weeks before they depart. It's a tough decision to make. It's like trying to predict what a stock will be worth on a certain day.

As a general rule, you shouldn't exchange all your money at one time because you could end up guessing wrong or converting too much money and losing again when you convert back to dollars or to another currency. Just because you got a good price exchanging dollars for pounds doesn't mean you'll get a good price exchanging pounds for French francs.


Information Please® Database, © 2007 Pearson Education, Inc. All rights reserved.

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