A Beginner’s Guide to Foreign Exchange
By Yi Chen Choo
Imagine that you’ve been planning a trip to go to your dream destination of Japan. Your goal is to eat all the amazing ramen and sushi that they have to offer. You arrive in Japan with a wallet full of Rupiah, ready to spend to your heart’s desire, but the restaurant shakes their head saying they only accept Japanese Yen. This is a crucial lesson you learn: to buy anything, you first need to trade your home currency for the local one.
This holiday problem is the window into a massive, complex global system we call the foreign exchange, or the forex. You might be asking yourself questions about this: How does trading currencies work? What determines the amount of Yen you get for your Rupiah? Does this matter only when travelling?
What is Foreign Exchange?
To start of, every country has their own money, which we call currency. Indonesia holds the Rupiah (IDR), the US has the Dollar (USD), and Japan holds the Yen (JPY). The place where these currencies are bought and sold is known as the Foreign Exhange Market. It’s the largest financial market in the work with trillions of dollars (USD) worth of currencies traded daily.
Understanding Exchange Rates: The Price of Money
The “price of one currency expressed in terms of another currency is called the exchange rate. For example, the exchange rate from USD to IDR currently is approx. 1 USD = 16,288 IDR which means that one US Dollar is worth the same as 16,288 Indonesian Rupiah.
Think about the Wantilan canteen. The “exchange rate” between your money and the butter chicken is 50,000 IDR = 1 plate of butter chicken and rice. This would mean that one 1 plate of butter chicken and rice would cost you 50,000 IDR worth of USD if you were to pay with USD, meaning you would pay about 3 dollars (not so expensive when you really think about it, huh?).
Why Do Exchange Rates Change?
Believe it or not, exchange rates between currencies change constantly! A currency’s value much like the popularity of a limited-edition JIS hoodie, increases when people want it (demand being high) (see prior Macroeconomics Articles for more information).
So what factors make a currency more or less “popular”?
Exports and Tourism:
When people in countries want to buy Indonesian products from abroad, like Kopi Luwak or Batik, they first need to buy Rupiah to pay for them as Indonesian merchants only want the currency of their own country. This applies to tourists who go to Bali for holiday during holiday season, they exchange their home currency for Rupiah in the forex market to be able to spend in Bali. The increased demand for the IDR during tourist season causes the Rupiah’s price to increase or in economics terminology, it appreciates relative to other currencies.
Imports: On the flip side, when lets say Japan wants to buy these Indonesian goods they need to sell their Yen on the forex to buy Rupiah in order to import these Indonesian goods from abroad. This increases the supply of Yen in the forex, causing its “price” to fall, depreciating the Yen.
This makes sense as while the Rupiah appreciates in relation to the Yen, the Yen must depreciate relative to the Rupiah.
Who Cares? Why Does Any of This Matter?
Believe it or not, this concept affect your everyday life.
A “weaker” or more “cheap” Rupiah makes imported goods more expensive. This makes everything cost more Rupiah to buy because you need more Rupiah to buy the other country’s currency. The price of that new Nintendo game from Japan or your Netflix subscription can increase because the cost to import them goes up.
On the flip side, the “stronger” or more “expensive” the Rupiah, means that it takes less Rupiah to buy more of other currency. This means that your next holiday budget will stretch further as your purchasing power increases.
Conclusion: Your Wallet is Connected to the World
The foreign exchange market shows us how interdependent our economies are as currencies are being constantly traded whic influence our daily lives. So, the next time you buy your favourite American snack, eat your favourite Korean instant noodle, or stream a movie, just remember that there there’s an invisible market involved in all of it!
