Exchange rates explained
OUR Aussie dollar moves up and down against the US dollar, euro, pound and yen daily – but what does it all mean and how does it affect everyday Australians? Here is a simple explanation of the impact of different exchange rates.
Imagine you wanted to buy an MP4 player online from America. You have Australian dollars, so you have to make two purchases (we will ignore transaction costs in these examples).
Firstly, you buy US$100 and then you buy the player. If the exchange rate of the Australian dollar is, say $1.05, you would need to spend fewer Aussie dollars to buy the US dollars so the player would cost about $95 (US$100/$1.05).
However, if the AUD dropped to 92 cents, you would have to spend about $108 (US$100/$0.92) to buy the US dollars before buying the MP4 player.
In other words, to convert overseas currencies to Australian dollars, always divide the other currency by our exchange rate.
So a higher exchange rate means goods bought overseas cost less. This is good for consumers but it puts pressure on local industries that have to compete with cheaper imported goods.
There's always another side.
Movements in exchange rates work the other way for exporters: they like it when the exchange rate is lower.
Let's imagine you write software programs and sell them to customers in America for US$100.
Once you have sold a program you want to bring the money back to Australia. If the exchange rate was $1.05, you would receive about $95 for the program. If the exchange rate dropped to 90c you'd end up getting about $111. (This doesn't take into account bank charges on the exchange and transaction.)
This is why farmers and miners who sell their products overseas don't like it when exchange rates rise. Their incomes fall.
In a global economy there are many forces impacting on exchange rates and the experts say no country can control the ups and downs. The movements and the impacts are something governments, consumers and industries have to learn to live with.
Nothing is this simple in practice, though in general terms there are always winners and losers from an appreciating Aussie dollar.
We hope we've made this much easier to understand.
Senior financial planner
Robertson Scannell Financial Planning