Cost of currency can be an unpleasant surprise

On the Money
From the September 5, 2003 print edition

“Money” is defined as “something generally accepted as a medium of exchange, a measure of value, or a means of payment, as in officially coined or stamped metal currency.” “Fiat” means “authorization.” Fiat Money is legal tender, especially paper currency, authorized by a government. We use “Fiat Money” in this country in the form of United States Dollars-bread, dough, cash, lucre, bucks, lolly, loot, shekels, smackers, rocks, you get the picture.

In economic terms, money represents command over good and services. But, here’s the chafe. In our ever shrinking world, where technology provides almost instant access to any country on the planet, the “unit of exchange” for command over goods or services is often unique to that particular nation. This gives rise to an entire industry called currency exchange.

Many of us are familiar with the British Pound, Japanese Yen, even Indian Rupees, but in addition there are over 40 other commonly exchanged currencies.

They are: American Dollar, Argentine Peso, Australian Dollar, Bahraini Dinar, Botswana Pula, Brazilian Real, British Pound, Canadian Dollar, Chilean Peso, Chinese Yuan, Colombian Peso, Czech Koruna, Danish Krone, Euro, Hong Kong Dollar, Hungarian Forint, Iceland Krona, Indian Rupee, Iraqi Dinar, Israeli New Shekel, Japanese Yen, Malaysian Ringgit, Mexican Peso, Nepalese Rupee, New Zealand Dollar, Norwegian Kroner, Omani Rial, Pakistan Rupee, Polish Zloty, Qatari Rial, Saudi Riyal, Singapore Dollar, Slovenian Tolar, South African Rand, South Korean Won, Sri Lanka Rupee, Swedish Krona, Swiss Franc, Taiwan Dollar, Thai Baht, United Arab Emir. Dirham, and Venezuelan Bolivar.

This gives rise to three levels of complexity facing persons involved in international activities.

1. The delineation of “command over goods and services” changes dramatically within regions. The cost of gasoline for example, is simply higher in some parts of the world than others, no matter what currency is used.

2. Currency exchange is based upon varying rates and usually requires an intermediary, similar to a stock broker. There is a cost associated with doing the basic conversion. The fee is similar to an “origination fee” in lending.

3. Market forces and perceptions cause fluctuations in exchange relationships amplifying any real economic change.

For the privilege of exchanging dollars into Swiss francs, a fee of up to 4 percent may be applied. That is, if while preparing for your trip to Geneva to buy some chocolate, you convert 1,000 USD into Swiss Francs (1,346 CHF as of today), you will pay $40. While this may be a small sum for the occasional traveler, for on-going business is can represent a significant impact on profits.

Using a credit card is a convenient way to accomplish currency exchange while traveling abroad, however it is not free. Furthermore, since the conversion is performed automatically, the cost is not immediately recognized.

American Express and a handful of major banks, including Citibank, the USA’s largest credit-card issuer, have added surcharges of up to 5% on purchases made in foreign currencies.

To further obscure the real cost of conversion, many banks use their own “exchange rates.” The exchange rates have the fee built in and are often different than the “spot price” of the given currency. Spot prices, or “foreign exchange mid-range rate,” are based upon banks exchanging currencies in amounts of $1 million or more.

Unless you take the time to check the exchange rate quoted in The Wall Street Journal (always on the back-page of Section C), or through the Internet by using a site such as XE.com, the disparity would never be revealed.

Currencies are in essence a commodity in themselves. Various factors, not unlike those affecting the perceived price of pork bellies or orange juice cause fluctuations that become a risk factor for international dealings.

In February of this year MetaFilter, Inc. reported that, “The Federal Reserve’s greatest nightmare is that OPEC will switch its international transactions from a dollar standard to a euro standard. Iraq made this switch in Nov. 2000, and has made out like a bandit considering the dollar’s steady depreciation against the euro. The dollar declined 17% against the euro in 2002.”

Companies can now use a broad range of financial arrangements to reduce or eliminate their currency exchange risk exposure. The most widely used instruments are the forward market and options. Commonly listed futures options in currency include: Japanese Yen, Canadian Dollar, British Pound, Swiss Franc, and Euro Dollar.

Leaving aside the accounting difficulties that an international corporation must deal with, any individual is well advised to consider the cost of currency exchange before making any exchange transaction. It can be an unwelcome surprise and there are no refunds-only more expensive exchanges.

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.