Foreign Exchange Rates
When a currency other than the local currency is used to settle international transactions, it is referred to as foreign exchange (or Forex or FX). The rate at which one currency can be exchanged for another is called the exchange rate.
Let’s say that today the U.S. dollar/euro exchange rate is 1 to 1, meaning that $1 can be exchanged for €1. Tomorrow, if the dollar weakens relative to the euro, then $1 will buy fewer euros. If the U.S. dollar is worth fewer euros, Americans will not be able to afford as many European goods and services. On the other side of the Atlantic, a stronger euro will mean U.S. goods and services will be more affordable to Europeans. American exporters will benefit from a decline in the U.S. dollar/euro exchange rate. However, American importers and consumers will not; prices for European products will rise, costing American importers and consumers of European products more. Conversely, when the U.S. dollar/euro exchange rate strengthens, and the dollar rises in value relative to the euro, then American exporters will find it more difficult to sell their products to Europeans because Europeans have to pay more in euros for the same American goods and services. However, an American importer or consumer of European goods will benefit from a rising dollar because the dollar will buy more European products.
The above is true because in international trade, goods and services are generally priced in their currency of origin. For example, cheese from France will be priced in euros. Wheat from Kansas will be priced in dollars. Now, when a country imports more than it exports, experiencing a trade deficit, the domestic currency’s value can drop relative to foreign currencies. This is because demand for foreign currencies has risen relative to demand for the domestic currency. Conversely, when a country exports more than it imports, experiencing a trade s