Expert: Gina Boykin - 4/28/2009

Question
QUESTION: Hello:

I have a currency trading question.  If one U.S. dollar buys or exchanges for a fractional part of another currency, is the U.S. dollar weak?

For example, If one U.S. dollar trades or exchanges for 0.7545 Canadian dollars, is the U.S. dollar weak?

I thank you for your reply.

ANSWER: The strength of a country's currency is based on the relationship with other countries' currencies, but this is more based on the change in the relationships, and not just one country with one country, but relationships with several or all countries.  

So the exchange rate of 0.75 doesn't make the US dollar weak, but if the rate was 0.85 and it is now 0.75 it is becoming weaker and if it increases from 0.75 to 0.80 it is becoming stronger (relative to the Canadian dollar).  At the same time that the US dollar becomes weaker compared to the Canadian dollar, it can become stronger compared to the Japanese Yen....so you really have to look at more than just two countries.

---------- FOLLOW-UP ----------

QUESTION: Hello:

I want to thank you for your reply, but I'm still somewhat confused.

Compared to just the Canadian dollar (not other currencies), is the U.S. dollar weak if one U.S. dollar exchanges for 0.7545 Canadian dollars since one U.S. dollar exchanges for a fractional part of the Canadian dollar. I would think that the U.S. dollar would be weak since it does not purchase a whole Canadian dollar.

I thank you for your reply.

ANSWER: In summary, this ratio does not determine a country's strength or weakness.

"Strength" of a currency is based on several factors, the biggest being nominal interest rates, inflation, current account balance, the outlook for future deficits, labor supply, trade balance and productivity.

So a ratio of 0.75 does not mean that the US dollar is 75 percent as strong as a Canadian Dollar.  Currently, the US dollar is equal to roughly 13 Mexican pesos; however, it does not mean that it is 13 times as strong.  

You really have to translate exchange rates into purchasing power to see why this is the case. For example:
 
Let's say you buy a soda here in the US and it costs $1.00, and that same soda in Mexico costs 6 pesos.  Even though 6 is greater than 1, it really only costs you about $0.50 in Mexico (1/2 as much as the US).  If we only went by the ratio above, we'd be saying that the US is 13 times stronger, but based on this one item, it looks like it may be only twice as strong.  

Of course, this is only one item and we can't base strength of the US on a soda, but it is just to illustrate that one ratio itself does not indicate strength or weakness.  If we looked instead at labor (which we know is cheaper than in the US), current interest rates and inflation, we can get a picture of why the US is stronger than Mexico.

Also, I looked up the current exchange rates, and it looks like you have the USD/CAD ratio backward. Currently 1 USD is equal to 1.2 CAD.  The ratio you mentioned is closer to the current CAD/USD of 0.82.

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QUESTION: Hello:

I want to thank you for your reply.

Let's switch currencies. When the U.S. dollar is weak against the euro, Europeans like to visit the U.S. so that they can get more buying power for their euros. For example, they will exchange one euro for perhaps $1.25 of U.S, money. So the U.S, dollar is weak against the euro.
Doesn't this make sense?

Answer
Again, this would depend on what you can buy with that 1 Euro compared to what you can purchase with $1.25.  If a cheeseburger costs $1.25 here in the US and costs 1 Euro in Europe, there would be no reason to travel here because there is no extra buying power.  If a hotel here costs $125 and a hotel in Europe costs 100 Euro, there is no more buying power for the Euro or the dollar.  This would again depend on what you can purchase.  

It is very unlikely that items would have the exact same number, and just a different currency sign (e.g. a pair of GAP jeans here that are $40 are most likely not going to be exactly 40 Euro - they may be 30 Euro or 50 Euro, and that difference determines whether there is more buying power or not)