If you have ever traveled abroad, sent money back home, or invested in foreign markets, you likely have wondered why currencies fluctuate.
Fluctuating currency exchange rates can cause the value of a nation’s money to increase or plummet in a moment. These changes can cause major issues for travelers and international businesses. Many people feel the effects on an individual level as well.
This article will help you better understand why the value of money can change and how to save money when the currencies fluctuate. Read on to find out.
Exchange Rate Fluctuation: An Overview
Why do exchange rates fluctuate? Simply put: supply and demand.
Money is similar to products you can buy in stores. A higher supply of a currency means there’s much more to go around. A higher demand can make it more valuable.
As an example, think of a new holiday toy coming out. If 1,000 people want the toy, but the manufacturer only makes 500, people may be willing to pay more to ensure they get the product. If the manufacturer creates 5,000 items, though, prices may not jump since there are enough toys for everyone.
You can read our Guide to Understanding Exchange Rates for a deeper dive. The following historic rates also show how currencies fluctuate continuously.
Value of U.S. Dollar (USD) Compared to Euro:
- December 2016: $0.95
- May 2017: $0.88
- February 2018: $0.81
- June 2019: $0.89
- March 2020: $0.90
- January 2021: $0.82
These fluctuating exchange rates show the value of a country’s currency abroad can experience dramatic changes. This happens in every country around the world.
However, one American dollar can be worth more in one country than another. Several factors can alter this value. For instance, the American dollar is valuable in Mexico at the time of this writing because of historic debt defaults, high inflation rates, and a relatively recent revaluation.
Sending money to someone in a country where the value of a U.S. dollar is low results in a poor exchange rate. Here are the currencies the U.S. dollar holds the least value against, at the time of this writing:
- Cayman Islands Dollar
- British Pound
- Omani Rial
- Jordanian Dinar
- Bahraini Dinar
- Kuwaiti Dinar
The U.S. dollar is more valuable in countries like Argentina, South Korea, Thailand, Brazil, Egypt, and Turkey at the moment. However, this could change at any time. Understanding why currencies fluctuate will help you know what to expect.
Why Do Currencies Fluctuate Constantly?
Investors usually consider these six major factors that influence the rates. These can help predict future rate changes and to better understand current rates.
1. Inflation differences.
One of the biggest reasons currencies fluctuate? Inflation rates. If someone transfers money from a country with a low inflation rates, they will often get a good deal. This is especially true if the money goes to a country with a higher rate.
For instance, inflation in America was 1.8% in 2019. In Mexico that year, the rate was 3.64%. This means the U.S. dollar had a favorable foreign exchange rate when sent to or invested in Mexico.
2. Different interest rates.
Central banks in countries can affect exchange rates and currency values by changing interest rates.
Higher interest rates mean foreign investors experience larger returns on their money. This can cause a country’s exchange rate to rise, but some issues can negate these benefits.
For instance, a country’s exchange rate may not rise with higher interest rates if inflation is currently high. This is why inflation and interest rates are closely related. Both can have significant effects on how currencies fluctuate, either together or on their own.
3. Account deficits.
When a country doesn’t earn as much on foreign trading as it spends, it creates a deficit. This usually means they need to borrow money. Doing so increases demand in foreign currencies. The exchange rate will go down in these situations.
4. Public debt.
Overseas deficits aren’t the only type of debt that explain why currencies fluctuate. When a country uses financing to fund government and public sector projects, they take the chance of increasing inflation. This makes investment from foreign sources less appealing.
To cover these debts, sometimes it is necessary to print more money or offer more foreign securities. Both these acts can increase inflation and have a direct effect on currency exchange rates between countries.
5. Strength of economies.
Investors want to put their money where they believe it’s safe. A country that consistently shows strong economic performance is a likely preferred choice for them.
It’s possible for political issues to play a role here as well. Investors are more likely to put their money in countries where perceived economic and political risks are lower. Even if all other things are consistent, differences in national stability can create major variations in exchange rates.
6. Terms of trade.
People often overlook terms of trade as a reason currencies fluctuate. This is because they often equate it to the issues described above. However, this factor has more to do with how price rates for imports and exports interact.
If export prices increase at a higher percentage than imports, this means that good terms of trade exist. This increases revenue in a country, which results in a higher demand for the currency. If import prices are higher, though, other countries will have the upper hand in exchange rates.
How to Save Money When Currencies Fluctuate
No matter the reasons currencies fluctuate, investors rarely have much to worry about. If a country’s exchange rate is not appealing, they can simply choose not to invest their money there.
However, for people who send remittances to family and friends back home, this isn’t an option.
The following tips will help you get the most out of your funds transfer.
1. Avoid retail exchange rates.
If you’re trading in money yourself, avoid retail exchange rates.
Experts also call these “tourist rates,” and they are what you will find in banks, airports, and currency exchange stands. These places will often charge a premium for exchanges.
2. Find good rates with money transfer services.
There are lots of money transfer services out there providing competitive rates. Make sure you search around to find the best rates for you.
3. Understand refund policies
If something happens, and you need a refund on a transfer, it’s important to know the policies of the service you used.
If problems or errors arise, being able to get a refund easily is important. We make this process simple at Remitly; you can cancel your transfer and receive a full refund as long as the transfer hasn’t been received or collected by your recipient.
Buying and Selling Currency
Most people deal with fluctuating currencies when they travel or send money abroad. There are also people who invest in foreign money. This is very similar to what happens on Wall Street.
People can also invest in currencies through foreign savings accounts, bond funds, exchange-traded funds, and other methods. Any changes in the supply or demand of these currencies can affect how much people are willing to pay for them.
The Bottom Line
Just because exchange rates change doesn’t mean you can’t save money when transferring funds abroad.
Remitly makes international money transfers faster, easier, more transparent, and more affordable. Our reliable and easy-to-use mobile app is trusted by over 5 million people around the world.