Why Do Currency Exchange Rates Change?
Published / Last Updated on 29/02/2024
We have explained in a previous video that money and currency exchange is exactly that, you are exchanging an item of value (or a promise of sterling when it comes to £20 notes) for goods and services with the equivalent perceived value.
Gold and silver, usually in the form of coins and weight was how money currency started. Currencies worldwide were linked to your gold reserves (maintaining the Gold Standard for strong currencies), but now that the Gold Standard has been dropped, a country’s currency is linked to its economy and the central bank’s ability to repay it’s debt i.e., the promise on its cash notes and coin.
See: What is Money?
Why are Currency Exchange Rates Important?
This is not just about your ‘holiday money’, exchange rates affect the costs of our exports when we sell goods and services to the world but also how much imports cost for both goods, services and raw materials.
Why do Exchange Rates Vary?
As mentioned above, the strength of your currency is linked to the strength of your economy driven by:
- A country’s ability to meet its own debt interest on government borrowing i.e., is its economy doing well so that both healthy corporate taxes and income taxes are paid to the Treasury to meet its debts.
- A country’s precious metals (gold, silver, platinum) reserves to be able to sell if needed to meet its debts.
- A country’s ‘debt and bond investment holdings with other countries’ for example the UK has bought/invested in a lot of US debt i.e. lend money to the US because it trusts the US to meet its debts as has China and Japan. If the US economy is doing well, it indirectly strengthens the £.
- The central bank’s interest rate as higher rates create demand for the currency i.e., more people will buy £sterling if interest rates are higher than other currencies.
This is why exchange rates change all the time as people are buying, selling, and swapping currency all the time and its perceived value changes depending upon demand as well as all of the above factors.
