Flexible Exchange Rates
Most exchange rates are determined by the foreign exchange market, known as forex. For this reason, exchange rates vary on a moment-by-moment basis, depending on what traders think the currency is worth. This depends on a lot of factors, including central bank interest rates, the country's debt levels, and the strength of its economy. Most countries allow their currencies to be determined by the forex market. This is known as a flexible exchange rate.Canada allows the forex market to determine its value. The dollar has strengthened since its recent low point on November 7, 2007. Back then, you could only get $.91 in Canadian dollars. That's because traders were concerned about the banking crisis, which was seen as strictly a U.S. problem at that time. As the 2008 financial crisis spread, traders flocked to the relative safety of the dollar. Why was the dollar safe? For one thing, the power of the U.S. economy is reassuring. More important, is the role of the dollar as a global currency. The dollar has effectively replaced the gold standard, thanks to the Bretton Woods agreement. For more on the dollar's role, see Value of the U.S. Dollar and Power of the U.S. Dollar.
Fixed Exchange Rates
One country that doesn't is China. It pegs its currency, the yuan, to a fixed value against the dollar. As of December 9, 2011, one dollar was worth 6.341 Chinese yuan. The dollar has weakened against the yuan since February 7, 2003, when a dollar was worth 8.28 yuan. So, for the same dollar, you could buy more in Canada, and less in China, than you could when the dollar was stronger.China changed the exchange rate of the yuan to the dollar. That's because the U.S. government is pressuring the Chinese government to let the yuan rise against the dollar. This allows U.S. exports to be more competitively priced in China. It also makes Chinese exports to the U.S. more expensive. For more on how this affects you, see U.S. China Trade Deficit.
Why the Euro Is Special
Most exchange rates are given in terms of how much of the foreign currency a dollar can buy. The euro is different. It is typically given in terms of how much of a dollar a euro can buy. It's hardly ever given the other way around. So, although the dollar was worth .75 euros on December 9, 2011, you would only hear that one euro was worth $1.33. The euro has weakened considerably since its all-time high of 1.6 on April 22, 2008, so the dollar has strengthened, because one euro was worth $1.52 in March, 2008. For more on the history of exchange rates between the dollar and the euro, see Euro to Dollar Conversion.(Source: Federal Reserve Bank of New York web site)Another, probably more important reason the euro is special is because it is the second most popular currency after the dollar. It is used by 332 million people as their sole currency. The euro's popularity derives from the power of the European Union, which is the largest economy in the world. Even though the euro hasn't been adopted by all EU countries, no other currency comes close to being a global currency.
However, the Greek debt crisis in 2011 threatened the viability of the eurozone concept. This lowered the exchange rate value of the euro in the last six months of the year. At the same time, the European Central Bank (ECB) started lowering its interest rate, after reaching a high 1.5% in July. This lowered bank rates for anyone lending or saving in euros, thus reducing the value of the currency itself. (Article updated December 17, 2011)
