How is the exchange rate set and who decides it? Is it the World Bank or the IMF or something? Is it based on stock exchange values? What is this new thing china is doing to allow more fluctuation?


Could someone explain to me or link me to a good overview of how currency exchanges are set?

http://www.x-rates.com/

might have what you are looking for.

Fair question.

Basically, it is the "market". So it depends entirely on demand and supply.

For instance, I have a hundred Australian dollars, and you want to buy them from me. I say, "ok give me 80 US Dollars and we have a deal". You say, "fuck that, I only want to pay $75". Finally, I say, "ok, fine, deal".

USD/AUD -- 0.75

That's the exchange rate... until someone else does a transaction for a different value. Maybe I was desperate to sell and you weren't as desperate to buy this time. Maybe next time, I have a feeling that the Australian interest rates are going up and I'll hold on longer for a higher price.

In reality of course we wouldn't have that conversation. We'd both look at what currency markets are doing and transact on that basis. And of course 99% of this stuff happens on the market via computers hooked up to currency trading platforms. There's literally trillions of dollars which change hands this way every day.

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Now this is what happens most of the time. We call those "floating exchange rates" Some countries have a "fixed exchange rate". That means for instance, that a country's government decides "that no one can buy or sell a Chinese Yuan for less than 12 US cents."

So it gets "pegged" to the US dollar. Why USD? Mostly because its the most widely traded currency in the world.

There are variations on this too.
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The World Bank and IMF are international bodies created by a number of countries that deal with loans to poor countries. Rich countries team up to lend money to poor countries and the IMF and Word Bank are in charge of administering those loans. So nothing to do specifically with forex.

Hope that helps!

Check http://en.wikipedia.org/wiki/Exchange_rate for further info too. But it's a little dense.

Some pretty appalling things happened in the seventies and eighties where people would buy huge amounts of a foreign currency at a cheap price. The supply of that currency would go down and therefore the price would go back up. They would then sell at the new higher price and fuck up that countries economy - their exports would do really badly at the inflated price and the market could crash when it was flooded.

As said by Shades_go_down, exchange rates are based on demand/supply....but a lot of factors drive demand and supply! oil prices, interest rates, economic factors are some of them...

If oil prices go up, there will be a greater demand for the USD/EURO since most of the oil is traded in USD/Euros...

If interest rates in India go up, there will be a greater inflow of USD in the country since more and more people will invest in Indian financial instruments. There will be a greater demand for the Indian Rupee.....

If a country's economy is in a bad shape, there will be lesser foreign investment in that country...people will want to take their money out of the country into a more stable economy....thus there are more sellers of the domestic currency than the buyers....currency depreciates...its value goes down!

This is just a basic explanation....currencies are also co-related with other currencies....for example - when Yuan was revalued, there was a huge demand for Asian currencies. People dumped US dollars and purchased Asian currencies......Rupee was at a all-time high that day....and so were a few other Asian currencies...

However the RBI (Reserve Bank of India) stepped in, purchased dollars and ensured that the Rupee doesn't appreciate....

The Fed, RBI and such Central Banks use monetory policy to control the currency rates...

Countries don't want their currency to appreciate coz that would mean lesser inflow of US Dollars....

eg: Day 0: 1 USD = INR 46
rupee appreciates on Day 2
I USD = INR 44

what is the impact on exports?
If I'm exporting goods worth $1 mn, I'll get only Rs 45 mn on day 1 as opposed to Rs 46 mn on day 0. Imagine an exporter who's profit margin was just Rs 1.50! He'll lose Rs 0.50 per USD....

US wanted China to revalue its currency very badly....why? coz once Yuan appreciates, US will have to spend lesser dollars to import goods from China!