Time to Revisit China's and the World's Foreign Currency Exchange Rates

Watching how a change in the amount one country's currency, such as a US dollar, can buy of another country's currency, such as Chinese yuan, illustrates globalization at work. Currency exchange rates certainly demonstrate how countries are interconnected.

     What brings this subject to mind (after it was addressed in the earlier post, "When to Buy/Sell in the World Market") is today's Chinese devaluation of its currency by about 2% against the US dollar. Based on information in the earlier post, kids who have an interest in finance might conclude China was attempting to reduce the price of its exports in order to compete with lower priced goods from other countries. China's imports of luxury goods and electronics from the US would cost more, and US tourists in China would get more for their money.

     In the past, China selected a midpoint currency conversion rate that fluctuated between 2% above or below the US dollar. As a result of China's first devaluation, the US dollar could buy 6.22 yuan compared to 6.11 the day before. The next day the value of the yuan dropped a little over 4%, but that is nothing like the 20% to 40% devaluation that would be needed to compete with much lower priced competitors like Vietnam or Burma. Although China did not want to risk losing investment capital that would exit a country whose currency has this kind of weak buying power, subsequent devaluations have caused capital to flee.

     The truth is, demand is weak within China, as shown by Alibaba's slowed quarterly growth. China's $50 billion canal project in Nicaragua has been put on hold until 2016. While no reason was given, the stock market dip has caused the fortune of Wang Jing, CEO of the HKND Group funding the canal, to fall from $10.2 billion to $1.1 billion. Yet, in December, 2015, President Xi Jinping announced China would be giving Africa emergency food and $60 billion in grants and loans.

     Weak demand throughout the world is hurting all exporters, including South Korea and Taiwan. Countries that depend on their commodity exports to China are especially hard hit as reported in the later post entry, "Falling Commodity Prices Spur Diversification in Emerging Markets." A 2% currency devaluation and even a 20% devaluation will not cure sluggish worldwide industrial and consumer demand.

   

   

   

   

   

An Example Helps Understand the World Economy

For dairy farmers in the United States, 2014 is an excellent year. Revenue from good prices for milk and milk products is up, and feed costs are down. Farmers can pay off debts and buy new equipment. Profits in 2015 are not expected to be as good. Why? Not because milk prices are expected to go down, and feed costs up, but because exports of cheese, whey, milk powder, and other dairy products are expected to decline.

     The U.S. dollar is strengthening in relation to foreign currencies. You  can check the value of the dollar against the Japanese yen, Russian ruble, and other foreign money at finance.yahoo.com/currency. On October 31, 2014, for example, one U.S. dollar only bought 109.21
Japanese yen or 41.01 Russian rubles. Today, a dollar can purchase 118.32 Japanese yen or 44.97 Russian rubles.

     How does the greater purchasing power of the dollar affect U.S. exports? People in foreign countries need to buy U.S. dollars before they can buy U.S. goods, such as cheese and whey. When their money can buy less expensive foreign currencies, they will buy less expensive products from U.S. competitors, and U.S. dairy product and other exports will decline.

     On the other hand, if a U.S. farm family always wanted to visit a foreign country, 2015 might be a good time to plan a trip. It could take fewer U.S. dollars to pay for foreign hotel rooms, food, and souvenirs, if foreign currencies are weaker in relation to U.S. dollars. (Learn more about foreign currencies at the earlier blog post, "When to Buy/Sell in the World Market.")

   

When to Buy/Sell in the World Market

Not only do countries have their own languages, they often have their own currencies. To name just a few, there are: Indian rupees, Mexican pesos, South African rand, Swiss francs, Turkish lira, British pounds, and Chinese yuan. You may see Chinese currency called renminbi (RMB) and wonder why. Just as "pounds" are units within British pound sterling currency, "yuan" are units within the overall renminbi currency of the Chinese Communists People's Republic. Smaller units of the yuan are the jiao (10 jiao = 1 yuan) and the fen (10 fen = 1 jiao). In every day "slang," Chinese people often refer to money as a "kuai" (piece), like the British would say a "quid" or Americans, a "buck."

     Within the European Union, euros have replaced the national currencies of countries such as France, Germany, Greece, Ireland, Italy, Portugal, and Spain. Euros also are the official currency of Andorra, Monaco, Slovakia, Vatican City, and several other countries outside the European Union. If students have never seen foreign currency, adults can pick up a TipPak (registered trademark) of coins and currency from Australia, Britain, Canada, Japan, or Europe at a local AAA office. Prior to an international trip, AAA is able to provide international travelers with more than 70 varieties of the foreign currency they will need on arrival to pay for taxis, tips, and other situations where credit cards are not accepted. Find out more at aaa.com/TravelMoney.

     Foreign currency has a different exchange value in relation to the U.S. dollar and other currencies. Since many of these values float, or change, the amount of currency needed to purchase another currency can go up and down within a day. Therefore, experienced travelers keep an eye on currency fluctuations and convert their Travelers Cheques to just enough local currency for a day or two. In order to make quick calculations, travelers also try to learn the value of foreign coins that are similar in size to the coins of their own countries. The website, finance.yahoo.com/currency, provides brief descriptions of foreign currency concepts. This website also is an easy way to keep track of the changing relationships between the U.S. dollar, Japanese yen, euro, Canadian dollar, U.K. pound, Australian dollar, and Swiss franc.

     An alumni magazine posed a clever foreign currency problem for its graduates. It said that a professional tennis player wanted to buy a diamond tennis bracelet for his girlfriend that was priced at 100,000 Swiss francs at the airport in Geneva. He was en route to a tournament in Spain, so he called the friend meeting him at the Madrid airport to ask the cost of a diamond tennis bracelet there. The friend said it was 40,000 euros. Rather than go to finance.yahoo.com/currency, the tennis pro saw that a copy of the International Herald Tribune was selling for 4 Swiss francs or 1.5 euros. He bought the tennis bracelet in Geneva, since at a 4 to 1.5 ratio, the bracelet should have cost 37,500 euros in Madrid, not 40,000.

     Ratios are the basis for determining foreign exchange rates. During the first few years after the euro's introduction in 1999, the annual average rate of exchange for one U.S. dollar was about 1.25 euros.
                                                      
                                             $1                                    x
                              _______________     =            _______________
                                        1.25 euros                           1 euro
                                                                             1
                                                       x        =      _________     
                            
                                                                           1.25

                                                       x        =      $0.80
                                                                                                                              
 Consequently, U.S. tourists realized their stronger dollars bought wonderful vacations in Europe and U.S. retailers took advantage of the opportunity to import European luxury goods. When one U.S. dollar purchased 1.25 euros and one euro was worth only $0.80 in 1999, a U.S. tourist paid $160 to purchase the 200 euros needed to stay in a European hotel room priced at 200 euros. By 2008, however, one U.S. dollar purchased only 0.64 euros, less than one euro. At that point, the purchase of European goods and travel to Europe grew prohibitively expensive. A U.S. tourist then had to spend $312 to buy enough euros for the same European hotel room that cost $160 in 1999.

     On the other hand, as the value of the U.S. dollar declined, the United States became an attractive destination for European tourists. U.S. manufacturers also found that the weaker dollar helped them expand their exports. When 1.25 euros were needed to purchase one U.S. dollar in 1999, European consumers paid 25,000 euros to purchase the $20,000 needed to buy a $20,000 U.S. automobile. In 2012, however, when only 0.77 of a euro was needed to buy one U.S. dollar, a $20,000 automobile sold for 15,400 euros. Likewise, European tourists could purchase $400 to stay in a $400 hotel room in New York City for 308 euros, compared to the 500 euros the same room would have cost in 1999.

     Children who track changing monetary relationships online at finance.yahoo.com/currency can become the family's financial advisers. They know when U.S. dollars will buy the most imported goods, international travel, and foreign currency. A family trip to Vancouver, for example, was a very attractive option in 2000, when the U.S. dollar was worth almost $1.50 Canadian dollars. In early October, 2012, however, one U.S. dollar was worth only 0.98 Canadian dollars. Ask youngsters to figure out how much a $100 hotel room in Canada would cost a U.S. tourist in 2012, compared to 2000.
           $1                                x                                          $1                               x
_____________    =     ____________                 ______________    =     _____________

       0.98                      1 Canadian dollar                        1.50                     1 Canadian dollar
       
                     x      =      $1.02                                                     x         =     $   0.67
  
The answer: $102 compared to $67.

     While worldwide economic stability makes planning for personal travel and business much easier, the art of forecasting foreign exchange fluctuations is an attractive career option for students who develop an interest in tracking foreign exchange rates. A company that expects to build a factory in Canada within the next year wants to buy the necessary Canadian dollars, when the U.S. dollar is strongest. Which way is the U.S. dollar moving in relation to the Canadian dollar, and what economic conditions, such as growth in gross domestic product, unemployment, inflation, and weather conditions, are likely to affect foreign exchange rates? It is up to would-be traders in the foreign exchange market (forex) to come up with these answers.

     Finally, girls need not shy away from becoming financial whizzes. The new U.S. Chair of the Federal Reserve Board is Dr. Janet Yellen, and Christine Lagarde is Managing Director of the International Monetary Fund.

(Also, check out the later post, "Time to Revisit China's and the World's Foreign Exchange Rates.")