ELI5: Who actually adjusts a currency exchange rate using global supply and demand data?

Submitted by nowjeon906 t3_z5wsfg in explainlikeimfive

I understand that for currencies that are not fixed to each other, their exchange rate reflects the supply and demand, or exports and imports, that the two currencies are involved in.

I want to know who, what machine, what algorithm ultimately adjusts the exchange rate I see on google if I do a "1 usd to jpy" search.

Is there an international organization out there that collects all the data involving two currencies, and automatically runs an algorithm that calculates the rate and informs of the current rate to everyone else?

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agate_ t1_ixyece9 wrote

No one person sets the price. It emerges through the actions of many buyers and sellers. Let’s suppose I run a bank and have extra yen and want to buy dollars. I offer to pay 139 yen per dollar. Other people and banks are less desperate to get rid of their yen: one offers 138, one offers 137 yen per dollar. Other folks are looking to sell dollars: they want 141, 140, and 139 yen.

I can do a deal with that last guy. I buy up his dollars, and now the low offer is 140. If I want more I’ll have to pay 140 for them. The new price is 140.

Now you come along with tons of dollars to sell. You sell me all I want at 139 yen. If you want to sell more, you’ll have to sell to the next guy who’s offering 138. The new price is 138.

At every moment, the price is set by the most generous offer that nobody is yet willing to meet.

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nowjeon906 OP t1_ixyp18w wrote

>I can do a deal with that last guy. I buy up his dollars, and now the low offer is 140. If I want more I’ll have to pay 140 for them. The new price is 140.

How does this kind of price-changing happens in reality? I suppose it is all instantaneous, so... Does each organization have their own software that automatically gathers data regarding current global prices (including the most generous offer across the network) and sets 139, 140, 141... accordingly as their offer price at that point in time?

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willtantan t1_ixyuost wrote

I am no expert. Below is just one hypothetical scenario. Let's say you go to a currency exchange stand to buy Euro. Euro price will be set by currency exchange stand, this price will include cost of currency stand business plus FX rates from their broker. Their brokers are probably some local small banks. Small banks will trade with larger banks like Citibank. Larger banks will trade with each other to set the FX rates. Governments will also participate in interbank market to influence FX rates. So FX rates are ultimately set up by interbank market.

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youknowthathing t1_ixyd5cp wrote

There’s no central place where currencies are traded.

Instead, large banks advertise an interbank rate that they will trade at - they do that by sending information to all the other banks through a wide range of e-trading platforms - including Bloomberg and platforms run by other banks like State Street, Deutsche etc.

There is a huge volume of transactions happening every minute - so prices tend to harmonise very quickly. Banks set their prices based on their internal supply and demand. If a bank is offering a good price, other banks will deal with them until they have exhausted that bank’s offer. If a bank offers a bad price, no-one will trade with them until they raise their offer.

Information services like Bloomberg, MorningStar and many other capture that information and make it publicly available - normally on a slight delay to the general public.

Many governments also require banks to report to them on fx rates in parallel to the above.

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Present-Clue-101 t1_ixycjj5 wrote

Techncially there isn't a single source and formula. Every company that publishes FX data (Bloomberg, Financial Times etc...) collects data from hundreds of sources such as banks, brokers etc... to come to a conclusion which is usually around the same ballpark due to similar methodology (especially considering that an FX rate can go into many digits after the decimal point). And generally everyone in the market will sell for around the same rate, with any "exceptions" being accounted for and excluded by the methodology. If someone were to sell/buy a large amount of a currency at a rate that deviates from the general FX rate, then it is likely that that currency trade would change the FX rate for the entire market.

The central banks also publish their own FX rates, but whether they themselves consider the rates to be "authoritive" differs from country to country.

Another authoritive source may be interbank exchange rates that are established by banks when they want to trade with each other - it is this rate that Google publishes and usually everyday retail FX rates are more expensive.

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nowjeon906 OP t1_ixyctaf wrote

Could you elaborate who is the "etc" beyond banks and brokers?

Do all these organizations have a similar degree of access to data regarding international trade done between two currencies?

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Present-Clue-101 t1_ixyf331 wrote

It's complicated because Bloomberg, Reuters and the Financial Times are usually top-level economic data companies that many banks themselves will source data from, but these media companies will in-turn source their data from the banks. Other sources include the central banks, brokers, IMF, statistics companies, investment mangagement firms, investors, companies that deal in large amounts of FX, etc... basically anyone who is considered by the media company to be affecting FX rates.

The top three that I listed above certainly have similar levels of access to financial data for live FX rates, but technically media companies will compete to provide the best FX rates possible so obviously there will be differences between companies.

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