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Currently, EUR/USD is 1.32395. I understand that this means I will require 1.32395 USD to buy 1 EUR. But, how is this rate determined? I also, understand that there are fundamental reasons which affect this rate and the pair (EUR/USD in this case) will go up or down. But, how did we arrive at the rate initially?

Also, why do I keep reading that US has the power the power to print as many dollars it wants? Isn't this also true with other countries and their respective currencies?

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    Primarily by market driven forces, exceptions include China where the government decides the exchange rate. – DumbCoder Nov 29 '10 at 13:06
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Today the rates are arrived simply on the basis of demand and supply. Historically rates were pegged to Gold, when all currencies were printed depending on the Gold reserves. So if one country printed 100 units of currency of a 1gm of gold and other country 10 units of currency for 1 gm of gold, the rate would be 1:10. However In the seventies with shortages of Gold and other reasons, USD became the default standard, so the rate started being pegged to the USD reserves the countries started maintaining.
However later in the early eighties, US backing out, the rate purely started getting pegged to market demand and supply. So for most currencies there was a default rate to begin with and today its changed ...
Incase of USD/EUR, the initial rate was determined by the weighted average of the currencies that it sought to replace. After that its been market supply and demand.
Since most of the trade in international market is US denominated, largest being Oil, each country has created a huge reserves of USD. So technically if China were to bank half its USD denominated treasury bills, the USD would come crashing down, but then China itself would be at disadvantage as its value of USD its holding would become less and it cannot buy the same items. Hence all countries keep hording USD and this means US if they print more money, the value will not come down, because it that happens, all countries holding USD would loose their value of reserve. In essence a country can print as much as currency it wants if all(majority) its debts and trades are denominated in local currencies. This is 100% true for US and hence it can get away by printing money. This is also true to a large extent for Japan as bulk of its Debts are denominated in JPY.

  • 'Hence all countries keep hording USD and this means US if they print more money, the value will not come down, because it that happens, all countries holding USD would loose their value of reserve' I didn't quite get that...can you please elaborate? Thanks. – tugga Nov 28 '10 at 5:37
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    @tugga: Lets say all other countries have USD100 and they want to keep this with them for future expenses say Oil which is again denominated in USD ... so when all these countries are holding USD, it means US at some point has to pay them these $100. Now if US needs say $100 to buy oil for itself, it would just go and print $100 and buy oil, the price of $ will not decrease, because if it happens it would mean that all other countries that are holding $100 would become $90, and they don't what that to happen. Hence as the US debt is in local ccy, it can get away by simply printing more $$ – Dheer Nov 29 '10 at 10:19
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    A word of caution, the explanation is more simplistic, the real world is more complicated. So its best to understand the principals isolated and try an create a consolidated picture. – Dheer Nov 30 '10 at 6:01
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Rates are arrived at by the cumulative buying and selling on the foreign exchange market, much the same way that stock prices are arrived at. If there are more people wanting to buy dollars with euros, EUR/USD goes down. If more people want to buy euros with dollars, then EUR/USD goes up.

The initial rate was about $1.18 per euro when it began trading on January 1st, 1999. It replaced the European Currency Unit at that time, which was a weighted basket of currencies of (more or less) the participating countries.

You're correct about the printing press in the US and other countries. The exchange rates do reflect in part how much of a relative workout those printing presses get.

protected by Chris W. Rea Oct 14 '16 at 11:53

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