Exchange rates are the amounts of one currency that you will need in order to purchase a set amount of another currency. There is what is called the official exchange rate, which is a daily statistical release sent out by the Reserve bank of a country as an indicator of that country’s relative position to other currencies for that day. It is an indicator only, as it is by definition an historical document based on observations of recent activity and not intended to be a precise and authoritative rate – more a summation of recent relative trades. Information forming the basis of an official exchange rate is based upon a market analysis for the particular day for major currencies and with averaged results based upon market observation for currencies considered to be of less importance or direct relevance. The official exchange rate will generally differ from rates quoted by dealers in the foreign exchange market simply because it is the foreign exchange market itself which defines the exchange rate as a result of many dealings in a day which in any individual case might vary from the official exchange rate in accordance with the law of supply and demand at the time the call is made. Any tourist experiences this discrepancy when cashing traveler’s checks while on holiday – the exchange rate in “change alley” may vary between money changers and with the rate offered by your hotel or bank.

Originally, exchange rates were stabilized by the International Monetary Fund, with currency valued against the US Dollar, tied to a gold standard. In 1971 this system was abolished by then President Nixon and the foreign exchange market technically became a free market. However, countries today will sometimes enter the forex market and make trades intended to influence exchange rates in the market, but it is no substitute for genuine demand to enhance the real value of a currency.

Some authorities consider it important to have a stable exchange rate, and this can be achieved by agreements to peg exchange rates between countries, and for some smaller economies this has some benefits. However, fixing exchange rates by agreement has the disadvantage of restricting capital movements and means that an individual country can no longer pursue an independent monetary policy. To have predictability in a market is good, but fixed exchange rates do impede market regulation by the law of supply and demand.

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