How Are Money Exchange Rates Determined?


Quick Answer

Money exchange rates are determined by the market forces of supply and demand, according to Investopedia. For example, if demand for U.S. dollars by Japanese investors increases, the price of the U.S. dollar goes up relative to the Japanese yen.

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Full Answer

Factors that influence the supply and demand of a currency are geopolitical developments, economic news, interest rates, unemployment rates, inflation, GDP numbers and manufacturing data. The website EconomicsHelp.org lists additional factors such as currency speculation, change in the country's competitiveness, relative strength of a currency versus other currencies, the country's balance of payments, government debt and government intervention.

An example of government intervention is the Chinese government's artificial undervaluation of the renminbi to boost Chinese exports, notes EconomicsHelp.org. An example of how adverse geopolitical and economic news can devastate a country's currency is Venezuela. According to a Feb. 19, 2015, Bloomberg article, the exchange rate back in 2003 was 1.6 bolivars per U.S. dollar. However by 2015, it went down to 6.3 bolivars per U.S. dollar in official exchange rates and 172 bolivars per U.S. dollar in the black market.

While many currencies float with market forces, some currencies, particularly those of developing countries, are artificially pegged to a stronger currency for short-term stability. For example, the Saudi Arabian riyal is fixed to the U.S. dollar while the Danish krone is pegged to the euro, as reported by Investment Frontier. These fixed currencies are reset to their peg currencies on revaluation dates.

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