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The U.S. Dollar: A History of Change
The officially recognized currency of the United States is the US dollar. It is abbreviated with the currency code ‘USD’ and is symbolized by a capital ‘S’ that is divided in the middle by a single vertical line (illustrated as $). Other names for the U.S. dollar are green, smacker, scrillas, dough, greenback, paper, dead presidents and buck. The dollar exchange rate is relatively high compared to other currencies. When analyzing the reason for this, multiple factors are considered. First off, think about the influence that the USD has on the world economy. Also, take into account the relative values of other currencies. Moreover, consider government policies that may influence such. All these shall be explained later on.
The Development of Modern U.S. Currency
The U.S. government officially promulgated the use of banknotes on 1785. But it was not until the declaration of the Coinage Act of 1792 that a federal monetary system was established. This act generated the first U.S. Mint and also established fixed denominations for copper, silver and gold coins (arranged respectively in increasing value). Non-interest-bearing demand bills, which are bills of exchange that are payable upon presentation, were issued on the year 1861. The very first denominations were worth $10.00 each. They featured an image of the 16th president, Abraham Lincoln.
Two years later, a national banking system with specific operational guidelines was instituted. These banks were responsible for issuing legal tenders secured by the acquisition of US bonds. Finally, on 1914, the modern day bank notes, known as Federal Reserve notes, were brought into circulation.
The United States mainly utilizes 7 denominations of its currency, with notes equivalent to one, two, five, ten, twenty, fifty and one hundred dollars. In the past, much larger denominations (five hundred, one thousand, five thousand and ten thousand) were released into circulation, but have now been phased out. Occasionally, one hundred thousand dollar notes were printed out for classified internal transactions.
The Great Depression
Before the current supremacy of the United States’ economy, it experienced some major downfalls in the past, the most notable of which being the great depression. It all started circa August 1929, when the United States experienced economic recession. Its GDP continuously declined until the stock market crashed on October 29, 1929 and, consequently, so did the value of the dollar. By this time, the dollar exchange rate reached a new low. This incident severely affected worldwide economy, causing great downfall of such. It is one of the biggest economy downfalls of the world. However, this also demonstrates the widespread influence American economy has on the rest of the world.
The scope and power of the US dollar is undeniable. Aside from being considered as one of the leading currencies worldwide, it has also been established as a benchmark in the Forex market (the world’s leading currency exchange market). Additionally, the USD is categorized as fully convertible. This means that it can freely be traded for other currencies because the government has not set any restrictions to such activity. As a result, it has become the most frequented legal tender in currency exchange markets. By the year 2011, the U.S. dollar became the primary global reserve currency and was held by almost every central bank in the world. Because of this, the United States’ monetary policy was held under close scrutiny of foreign nations. It was done to guarantee its stability, as it can affect the value of their reserves.
This so called reserve currency is a foreign unit of money held in a country’s major financial institution. It is used as a mode of paying off intercontinental dues or accounts and some commodities such as oil or gold. Additionally, this also affects a nation’s domestic exchange rate. Ultimately, currency reserves significantly reduce exchange rate risks because instead of converting the national legal tender, funds from the reserve currency can be used to make purchases.
Because the U.S. dollar is versatile and is universally acclaimed as the most traded currency, non-U.S. countries have decided to adapt this legal tender as their own. This is a process called dollarization. Samples of which include Ecuador, Bonaire, Panama, East Timor, El Salvador, Marshall Islands, Saba and Sint Eustatius.
Currency PairsThere are 2 major categories of currency pairs: indirect and direct. In the case of an indirect quote, the currency at hand (domestic currency) is considered as the quote, whereas the unit it is to be converted into (foreign currency) is labeled as the base. Conversely, in a direct quote, the domestic currency is the base and the foreign currency is the quote.
EUR/USD (Dollar to Euro)
Statistics reveal that the most popular currency pair is the dollar to euro, the latter being the major currency of some European countries. Conversion of these values is popularly referred to as trading the “euro.” If the trader is American, the above pair can then be called an indirect quote. Now, some may ask, “can this be written as USD/EUR instead? The answer is yes, but it is not recommended.
The format follows a simple rule: the first unit written is the bigger value (base currency) that is usually represented as 1 (one), whereas the smaller value (quote currency) is placed last. This makes the process of conversion easier. The EUR/USD format is therefore interpreted as one euro for every ‘x’ U.S. dollars. The ‘x’ in this statement is a dependent variable that is influenced by political factors, economic conditions and market psychology. It represents the value of the dollar. For example, the trade is valued at 1.25. This means that one euro is worth 1.25 US dollars. Over the course of time, differences between the two have continually fluctuated. However, the euro has consistently held a higher value over the U.S. dollar. The interest rate differential (IRD) between the central bank of the U.S. (Federal Reserve) and of countries that use euro (European Central Bank) influence the value ratio of these two currencies. For example, a financier loans USD 1,000.00 and exchanges this for euros. The financier now has acquired a European Nation bond. If, per se, the said bond bears a seven percent interest and, congruently, the U.S. bond generates three percent, the difference between the two (7 minus 3) equates to four. Therefore, the IRD is 4%. This value is the estimated proceeds the financier can expect in a carry trade. However, this statement only remains true if the euro and dollar exchange rate remains constant. If the Federal Reserve (FeD) decides to intercede in open market interactions to strengthen the USD, hypothetically speaking, the worth of the euro should congruently decrease. By rule of thumb, the stronger currency should have the bigger value.
GBP/USD (Dollar to Pound)
Another currency trend is the dollar to pound pairing, with the latter being the official currency of the United Kingdom. It ranks as the 3rd most actively traded pair in the forex market. Following the same rules as the EUR/USD, this can be quoted as one British pound for every ‘x’ U.S. dollars. Trade vales usually range from 1.50 to 1.60. Dollar to pound conversion is commonly referred to as trading the “cable.” And although an estimated 9/10 of overall currency trades made worldwide include the USD, this pairing is also quoted indirectly to the American trader. The rationale behind this mostly falls to convention.