Have you ever wondered:
A. Why 1 European Euro(€) is not equivalent to 1 Great British Pound(£)?
B. Why the US Dollar($) is significantly stronger than the Nigerian Naira(₦)?
C. Why Arab nation currencies are particularly strong?
D. And what causes these monies to rise and fall in the global markets?
↓Well, let's get the answers to these Questions↓
I'll give you the TL;DR now, you may read on for deeper understanding if interested:
A. 1 Euro is not equivalent to 1 GBP because there is more demand for the GBP as it is deemed by foreign investors to be a more strong and stable currency.
B. The USD is significantly stronger than the NGN largely due to economic and geopolitical factors. The economy of the United States is deemed to be far more secure by investors, meaning the currency carries more perceived and real value. Inflation rates in Nigeria are also significantly higher and poorly managed meaning any realised capital gains may not retain purchasing power - further turning away investors.
C. The Kuwaiti Dinar (KWD) has consistently been the strongest currency in the world. Substantial oil and gas reserves in these Arab states mean exporters and importers create a high steady demand for these currencies. There is also great incentive for investors to enter the markets looking for stable returns. Further, many of these currencies are pegged to the USD and their central banks use their great capital reserves to maintain this fixed rate.
D. Currencies are paired against each other on the foreign exchange markets. Global demand and supply for these monies cause their rates to rise and fall relative to one another. Many factors in individual countries affect supply and demand and thus indirectly alter the exchange rates.
What Are Exchange Rates
Currency exchange rates describe the price of one country's currency in terms of another. These rates determine how much of one currency can be bought for a specific amount of another. Real currency exchange rates can be found easily online or at currency bureaus, although, the latter have a markup for their margin.
Currency strengths are relevant mainly when comparing or operating between two economies. Those inside of the economies carrying out ordinary domestic financial operation do not typically experience/notice these changes in valuations.
There are a few types of exchange rates: floating exchange rates are used by most major economies and are solely determined by supply and demand market forces. fixed exchange rates are managed by governments or central banks to hold their currency value within a narrow range; usually pegging it to the currency of another major currency. Forward rates are agreed upon exchange rates between two parties for transactions that will take place at a specific date in the future.
Currency Rate Significance
A high relative exchange rate denotes a strong currency. This strength of currency gives a broad stroke indication of a nations economic health. Foreign monies, through investors and companies, seek out strong, stable economies to invest their capital. Investors must buy more of the country's currency to invest in their economy, further driving up its exchange rate. Exchange rates in essence are a description of the demand for a countries currency.
Interest rates & Inflation (which are highly correlated); A country's trade situations; and economic & geopolitical factors all lend to the perceived stability of a nation's economy and posed risk to invested capital. Descriptions of these variants are as follows:
- Inflationary Changes - Lower inflation means more purchasing power relative to other currencies -> the currency strength increases.
- Bank Interest Rates - Higher interest rates attract foreign capital as this generates higher returns than in other countries -> Exchange rates rise.
- Current Account Deficits - a country holding a deficit in trade (more spent on imports than exports) requires more foreign currency than it receives through sale of exports -> Lowering exchange rate.
- Public Debt - public sector and govt funding usually lead to large debts and deficits. Nations with larger deficits are less attractive to foreign investors - Leading to lower exchange rates.
- Terms of Trade - the balance of trade(exports/imports) prices. E.g. If a countries prices of Exports increases more than the price of its imports, its terms of trade has improved - in turn increasing export revenues. This indicates a greater demand for the countries exports.
Many ever-changing factors play into the currency exchange marketplaces - explaining their volatile nature.
How Exchange Rates are Calculated
Summarising all said before: A currency's exchange rate is determined by global supply and demand pressures.
The Forex market allows exchange from one currency to another. Similar to a barter system, the currencies are traded between parties based on perceived value. A stronger currency buys more of a weaker one.
Forex pairs state the rates between currencies and are crucial in understanding how the rates are calculated. The most popular Forex pairs by volumes traded are: EUR/USD, USD/JPY, GBP/USD & USD/CHF. The US is the global reserve currency and so, it is coherent that the most popular exchange pairs include and are priced in its currency. Interestingly, exchanges between the US dollar and the Chinese Yuan are far less frequent. This is due to the relationship between the two nations and trade tensions.
There are no direct calculations for exchange rates, it is simply just a price. The price at which buyers are willing to buy one currency for another. Rates fluctuate on the market in response to currency exchanges by traders, companies and governments. Central banks may also influence the foreign exchange rates by buying or selling huge amounts of the currency to manage the overall perceived stability of the country's economic standing.
In the UK alone, over £1 trillion of currency exchanges takes place everyday! With daily estimated global exchange numbers being $9.6 trillion (or £7.25 trillion :) )
Closing
Exchange rates are not set by banks nor fancy formulas. They are simply subject to global marketplace supply and demand, pitching economies against one another. The UK (5th strongest) and the US (10th strongest) have strong currencies and strong economies amongst many Arab oil rich states in the global rankings.
For knowing's sake, the weakest currency globally in 2025, is the Lebanese Pound.
1 GBP buys 118,640 LBP
Factors such as major armed conflict, political instability, hyperinflation and a depressed economy contribute to this less than favourable status.
Question to Ponder
Why is the GBP still stronger than the USD despite the US dollar being the global reserve currency? Answer
