A simplified guide to international exchange rates and fees
International exchange rates are part of what make the world’s economy so dynamic. The constant ebb and flow of rates rising and falling make some frustrated, while others are left elated. Understanding and mastering international exchange rates is an important part of running a global business; falling for the misleading information often presented can leave you with a lot less money in your pocket. We’re here to bust a few myths when it comes to currency exchange rates and fees.
What affects exchange rates?
The events happening at any given time determine the demand for a said country’s currency; the strength of the economy, serious political events, even the weather. The interest rate paid by a country’s central bank largely contributes to how much in demand a certain currency is. If the interest rate is higher, then the currency becomes more valuable.
What happens is that when a currency is seen as more desirable with a high interest rate, investors exchange the currency they have for the higher one. The country’s bank then holds onto the exchanged currency in order to eventually receive a higher interest rate.
A country’s money supply is pertinent to the country’s central bank activity and decision-making processes. For example, if a government prints too much of their currency, then that is indicative of a problem: there’s too much money around that is going after too few goods. As such, holders of this country’s currency create inflation by budding prices up of local good and services. A more extreme case would be hyperinflation, which is characterized by too much money being printed as the result of having to pay off war debt, or some other large, national debt.
Similarly, any economic growth, or lack thereof, has the ability to strongly impact the status quo regarding a currency’s exchange rate. The country’s goods and services will only be invested in if their economy is booming, because it will need more of the currency itself in order to continue providing said goods and services. If a country isn’t demonstrating little or no stability, there will be less willingness on the behalf of investors to invest in its currency.
Myth #1: There are many different exchange rates
What can become quite confusing and misleading with exchange rates, is the notion that there are many, many different exchange rates. If you call your bank and ask them what “their” exchange rate is for transferring one currency to another, you’ll get one “rate”. If you check at your local change shop, you’ll get another. Is a customer expected to shop around to find the best rate?
There is only one, true currency exchange rate. That is the mid-market rate (or inter-bank rate). It is basically a midpoint between supply and demand for a specific currency in the global markets, and because supply and demand are not fixed entities, they change all the time. At any given moment, there is only one mid-market rate. If you want to find out what it is, check out Yahoo Finance, XE, or any other independent source (not a financial establishment). This leads us into our next point, where commissions and fees play a role.
Myth #2: 0% commission
When withdrawing foreign currency, the first thing that might come to mind is the fee: What will I have to pay to change X currency to Y currency? Many financial establishments will promise you “0% commissions” or “no fees”. Are we to believe they’ll be changing the money for free?
Regardless of the commonly promised “no commission fee” establishments that you can find in many places, such a concept doesn’t really exist at the end of the day. What often happens is that the establishment will calculate their fees to be included as part of the exchange. For example, if the exchange rate from EUR to USD is €1 = $1.20, your bank may tell you that “their” exchange rate for these currencies is €1=$1.16. This makes it appear, to the unsuspecting customer, that there is no fee. But what does this essentially mean?
If you change €100 to USD, you should get $120. However, the bank has a 3.3% fee for exchanging these two currencies, so you’ll only end up with $116 in your pocket at the end of the day (they took $4 as the fee). See how this works? 0% fees is actually 3.3% fees in this case.
The good news
Frustration towards an entity that is very difficult to control is a completely understandable reaction to have towards international exchange rates. However, next time you have to exchange currencies, just know that you do, in fact, have more of a say in the matter than before.
At the end of the day, the only reliable and transparent exchange rate is the mid-market rate. If you’re transferring money from one currency to another, work with an entity that doesn’t hide its exchange fees. No secrets, no “0% commissions” fallacies.
Naturally, there will always be fees, but in order to accommodate the public, while they are entitled to their share for providing the service of exchange, companies that exchange funds should strive to ensure that the focus of their services stays on doing whatever they can to ensure that a customer gets as much of the exchanged currency as possible. If you come across another exchange rate establishment, claiming to have the ‘best rate’, or work without commission, ask them about the real fee, and they’ll give you the look of a deer in headlights.