If you have been travelling overseas for any length of time, you will have noticed how easy it has become to transfer Australian dollars into the currency of whichever country you are in. Such is the wonder of global finance that most of us can simply use an ATM of any bank in another country. Our bank talks to that bank and, voila, we have cash in our hand and a debit from our account.

When you stop and think about this transaction, it is quite remarkable. In our hand we are holding Indian rupees, British pounds, Vietnamese dong, Peruvian pesos, etc. But the deduction from our bank account is in Australian dollars. So, what actually happens when money is ‘transferred’ overseas?

Let’s say you are visiting India. Your Australian dollars are no good there. You need Indian rupees if you want to taste the delights of street stall chai (and they are delightful). You need to find someone who will ‘give’ you some rupees. Now, nobody will simply give you rupees. But there are some people who are willing to exchange their rupees for your Australian dollars. Who are these people? They are people who want to buy something for which they need Australian dollars. An Indian tourist wanting to come to the land of the soy latte, for example.

The exchange of dollars and rupees happens in a market. In this case, the market is made up of people who want to buy or sell either Australian dollars or Indian rupees.

Like all markets, the price at which a trade happens is determined by demand and supply in that market. When you enter the market with your Australian dollars looking for a swap into Indian rupees, you are simultaneously supplying dollars to the market and demanding rupees from it. If everything else stays equal, then increasing the supply of dollars reduces the price of those dollars. And increasing the demand for rupees increases the price of rupees.

Of course, things never stay equal. You are not the only one looking to swap dollars for rupees, or vice versa. So, in the market there are lots of people needing to buy or sell rupees or dollars. For example, in 2021, India imported $US15 billion worth of things from Australia and exported about $US 9 Billion over the same period. All of these importers and exporters act together to affect the exchange rate – and this rate can cause that rate to move around a lot, as this graph of the past 12 months shows (thanks to Google):

The graph shows how many Indian rupees a single Australian dollar could buy. The rate fell as ‘low’ as 51 rupees in October 2022, and went as high as 58 rupees in February 2023.

Interestingly, it is not just the import and export of goods and services that impact exchange rates (remember, an Australian tourist buying a chai on the side of the road in Jaipur is, technically, ‘importing’ that item from an Australian financial perspective). One of the really large influences on exchange rates is the relative interest rate between any two countries. Because it is so easy to move money around internationally, when interest rates rise in one country relative to another, some investors are attracted to invest in that country. But to invest in an interest-bearing investment in Australia, for example, you need Australian dollars. So, if interest rates in Australia rise relative to India, that will likely cause an increase in demand for Australian dollars. This should drive the value of the $AUD higher relative to the Indian rupee.

This is one of the reasons that movements in Australian interest rates are not solely linked to what is happening in our domestic economy. World markets matter as well. Interest rates are rising in most parts of the world right now. If rates rise elsewhere, but not in Australia, then demand for Australian dollars will fall.

Just to add another layer of complexity, a fall in the value of the Australian dollar is not necessarily bad. It raises the price of things that we import (including holidays that we take overseas). But, for people in other countries, the cost of importing things from Australia falls. This is one of the reasons that we sometimes see ‘Hollywood’ movies filmed in Australia – the US-based investors get more bang for their buck in Australia than they would in the US. Especially if the Aussie dollar is low compared to the greenback.

A ‘low’ Australian dollar, then, can lead to an increase in exports and a reduction in imports. Or, it can just add to inflation if the things we import cannot be avoided. This of course means that when Phillip Lowe and the RBA board sit down each month to discuss interest rates, they need to factor in the foreign exchange effect of any decision they make.

Big and complex decisions, these. Best made over a nice cup of freshly-brewed chai.