currency, foreign-exchangeAccording to Google, right now
1 U.S. dollar = 13.6595227 Mexican pesos (MXN)
Does this imply that USD is relatively stronger than MXN?
On one hand, that’s what common sense tells me.
On the other hand, I happen to think that any currency is just some artificial construct that could (more or less) simply be scaled. For instance, when the Peso was invented, what we call now ‘1 Peso’ could have just as well also been ‘0.01 Peso’ (I know it’s not that easy, yet I guess the principle holds).
In that case the aforementioned equotation would change to
1 U.S. dollar = 0.136595227 Mexican pesos (MXN)
, resulting in the Peso appearing relatively stronger.
What is actually correct?
Neither. The value of one unit of any currency is an arbitrary scaling factor conveying no information at all. All that has meaning is the change in the exchange rate between two currencies over a period of time. If the peso goes from 15 pesos to the dollar to 10 pesos to the dollar, then it has strengthened against the dollar. If it goes the other way, then it has weakened against the dollar.
Largely speaking, the absolute value of a currency is somewhat arbitrary. It’s usually been determined at some point far in the past, based on the size of small financial transactions that might typically take place at the time.
So, the difference in nominal absolute values might imply something about changes in economic situations between two currency areas, if you know something about when the currencies were introduced / rebased. However, that’s really stretching it.
It’s changes in one currency relative to others that might tell us something about changes in economic outlook for a particular currency. To get an idea of the status of a specific currency, one might either look at its value against a basket of other currencies; or against a very liquid currency against which it floats in value, e.g. the Euro [EUR], the Swiss Franc [CHF], UK Sterling [GBP], or the US dollar [USD]).
One way of looking at a currency is to think of it as equity in a nation (or other currency area). So, for example, GBP could be thought of as equity in the UK economy. Extending this analogy, changes in GBP’s exchange rate with EUR / CHF / USD can indicate something about expectations about future income streams (UK interest rates), about consensus expectations of the UK economy, and of future equity dilutions (e.g. through Quantitative Easing). But that’s only an analogy, so don’t extend it too far.
More simply and directly, changes in exchange rates reflect changes in demand and supply of that currency, relative to other currencies.
As an exception to the above answers, I would conjecture (on the basis of a single point in time) that a currency with an extremely large exchange rate relative to USD is probably hyperinflating and in that sense is relatively weaker. An example is the Zimbabwe dollar. One justification for this is that a government must redenominate its currency in order to bring its exchange rate down (which should eventually happen because it’s more convenient for everyone not to have to deal with so many zeros), and this can’t be a continuous process (but it can be a recurring one as in the case of Zimbabwe). Also in the comments Jason B brings up the example of the Peso having been rescaled in this way.
The converse is that a currency with an extremely small exchange rate should be relatively stronger, and this seems equivalent although somewhat counter-intuitive to me. But I suppose if I were to ever spend 100 billion USD on a single item I should expect it to hold its value better (hyperdeflate) relative to USD itself. And looking at the problem cross-eyed, I imagine would save a lot of money on firewood if I could buy 100 billion paper notes of foreign currency for a single dollar.
So I think “the exchange rate conveys no information” is true as long as the logarithm of the exchange rate is close to 0, but otherwise, given hopefully reasonable assumptions, anything goes.
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