Is an exchange rate like a national share price?

by Daniel on February 24, 2016

So, this morning I had a brief Twitter conversation with Simon Jack, the economics editor of the Today programme, about a metaphor he used to introduce an interview on the subject of the British Pound’s sharp devaluation as the EU exit referendum was launched. The line which annoyed me at seven o’clock this morning was:

“I think of the exchange rate as something like a national share price, and ours has been falling”

See below for why, although I understand the point he was trying to make, I think this is not a good way to think of exchange rates…

[Note: I am prepared, here, to set aside merely technical points, related to the fact that exchange rates, unlike share prices, are ratios. This means that there are always one fewer exchange rates than there are countries, and it’s not possible for them all to increase at the same time, something which isn’t true of share prices. This point of disanalogy does, in fact, annoy me, but I don’t think it’s particularly harmful for people to not know it].

The point that Simon was making, and one that I regard as basically valid, is that, like a share price, short term movements in the exchange rate (in this case, the sterling/dollar exchange rate) are usually caused by a temporary disequilibrium in net capital flows, which are themselves usually a result of changes in expectations or sentiment on the part of investors and/or speculators. So broadly speaking, the inference from “sterling fell” to “people in the market saw this whole referendum mess as bad news” is valid.

But the trouble is that both share prices and exchange rates have equilibrium states as well as movements in disequilibrium. And the equilibrium conditions are totally different. For a share price, it’s the capitalised value of future profits, and pretty unambiguously, higher is better and lower is worse. For an exchange rate, it’s the ratio of two sets of prices of tradable goods. And depending on all sorts of other things, it might be better or worse for the exchange rate to be higher or lower than it is today.

Which is why I don’t think this metaphor can be defended as a simplification for the layman. A layman hearing the report I heard will be reasonably well informed about this week’s currency fluctuations, but he will take away the message “an exchange rate is like a national share price”. As a result of using that rule of thumb, he is quite likely to develop very wrong beliefs about, say, whether it would be good for sterling to trade at US$2, or whether it would be good for the UK if the Chinese yuan appreciated (and therefore the pound depreciated). And, of course, because the definition of “a layman” in context is “someone who doesn’t regularly follow the financial news”, the economics editor of the Today program won’t get an opportunity to tell our imaginary listener when he’s got the metaphor wrong.

I’m not sure what a good metaphor would be. My best idea so far would be to think of the exchange rate as something like the national blood sugar level. If it surges or plumments in a short period of time, there’s usually a reason for that. It might need to be higher on average than it is now, or lower on average, but the important thing is not the absolute level but the need to get it in balance with what’s healthy for the system as a whole, and it’s usually a bad sign if it’s very volatile. This isn’t perfect by any means – it obviously leaves the hypothetical layman with a very wrong impression of the merits of fixed exchange rate regimes – so I’d be open to any suggestions. The correct communication of economic and financial information is a fascinating subject for me, and it’s the sort of thing I’d do a PhD in if the thought of doing experimental economics questionnaires with student volunteers didn’t seem so dispiriting.

If you absolutely must have a Brexit thread, I suppose this can be it, but for heaven’s sake try to keep it less intolerably mindless than the majority of British public debate on the subject.



P O'Neill 02.24.16 at 2:38 pm

Blood sugar is a very good one. Bad when it moves too quickly but is responding to biological fundamentals.

Another one could be financial barometric pressure. H and L mean different things depending on season, air and water flows and other factors. Storm Brexit?


Daniel 02.24.16 at 2:45 pm

I’ve been chatting to a guy who works at the Met Office about this sort of subject, because the weather forecasters are, of course, really good at communicating risk in a way that people understand (US forecasters use percentage probabilities, but I’m more interested in the UK concept where people know the difference between “showers”, “scattered showers”, “occasional rain” etc). Their big recent innovation has been introducing the “named storm” concept into the UK and I now wonder if it might help financial literacy if market episodes were given names – rather than all the unwieldy talk about “2008-9” or “The Lehman episode” and “The Grexit crisis” (which actually had several phases) we could talk about “Crash Susan” and “Crash Geoffrey” etc.


Pete 02.24.16 at 3:02 pm

Why don’t we hear people talking about the “current account deficit” any more? And the corresponding capital account surplus which comes from selling UK property to overseas investors? Of all the export industries to have, housing has to be the least sustainable.


Lupita 02.24.16 at 3:13 pm

If currency depreciations are like diabetic shocks, then high reserves are must be the pancreas of the system. At least that is how many 3rd world countries have defended themselves from the hedge fund attacks and financial crashes so common in the 90s.

It’s all a game and it’s rigged. 1st worlders did not want to recognize this because they were the beneficiaries of the system. Things are changing now. The rot is reaching the core.


Trader Joe 02.24.16 at 3:15 pm

I’m fond of the Benjamin Graham metaphor, first applied to stocks, but I think also applicable to FX rates:

In the short run, the exchange rate is a voting machine in the long-run its a weighing machine. Which is to say initial movements describe trader reactions to news, data, policies, events etc. while in the long-run a valuation provides a sense of relative worth compared to other currencies.

It allows us to say that the Pound (or dollar or whatever) weakened today, this year etc. but that it remains as currency much stronger than X, Y or Z and likewise much weaker than A, B or C. As per the analogy in the opening paragraph – there are no inherently right or wrong weights, but some are clearly more healthy than others at certain points in time and in the long run being too heavy or too light has a consequence.


pnee 02.24.16 at 3:25 pm

One complication with the blood sugar analogy is that different constituencies within a country might see the “right” level as being different.

So, the wealthy might want a strong reserve currency with buying power overseas, whereas people working in an export industry with foreign competition might like a weaker currency.

Maybe this also happens in physiology (the liver and pancreas disagree?) I have no idea.


Neville Morley 02.24.16 at 3:25 pm

Another vote for the potential usefulness of the blood sugar level metaphor – so long as you’re happy with the possibility of it being extended to different sorts of fiscal and monetary policies as being the equivalent of scoffing Haribo rather than eating a healthy piece of fruit…

But I’m less convinced of the wisdom of taking the Met Office as a shining example of this, given that there’s research (no refs, but there definitely is) to the effect that most people retain very little information from the forecasts, perhaps precisely because they’re presented in chatty language.


Lupita 02.24.16 at 3:52 pm

Rich and powerful countries are diabetics overindulging on cake whereas the poor are hypoglycemics having to skip meals.


Mark 02.24.16 at 4:23 pm

“Panic Robert”


marcel proust 02.24.16 at 5:09 pm

… for heaven’s sake try to keep it less intolerably mindless than …

Gimme a break. I strongly believe that a majority of your audience is American (or United Statesian if you want to be picky). Don’t you have any idea what it means to be American? Intolerably mindless leads the list fer cryin’ out loud. Talk about pissin’ into the wind…


Bruce Wilder 02.24.16 at 5:30 pm

Yes, because Donald Trump has nothing on Viktor Orban, other than United Statesians have mostly never heard of Viktor Orban.


A H 02.24.16 at 5:57 pm

Are stock prices not exchange rates though? They are a ratio of a share to a unit of (interest bearing) currency. Then it is less clear that a rising stock price is unambiguously good. If you are going to receive currency in the future and then plan to buy stocks (e.g. a pensoin), rising stock prices are certainly bad. Just an interesting way of looking at things.


ragweed 02.24.16 at 6:14 pm

A H has a point. The stock price analogy is only a problem when people don’t understand that stocks can be overpriced.


Paul Davis 02.24.16 at 7:17 pm

A useful way for me to think of exchange rates (beyond the ‘voting machine’ popularity contest phase) is as a language dictionary. One tribe does all their internal communication about supply and demand, working out what to produce and how to trade it, via ‘frobnitz’. Another measure the same commodities and similar processes in ‘splats’. To the extent that tribe one wants to exchange the things that are relatively more difficult for them to produce with those that are relatively difficult for tribe two to produce they have to have a way to translate frobnitz to splats in a way that roughly equal frobnitz-splats quantities go each way.

For my own requirements I try to always have a few of both frobnitz and splats on hand.


Ronan(rf) 02.24.16 at 8:20 pm

Since we can talk about brexit, although I can’t promise not to be mindlessly dumb..
Does a yes plausibly go like this (1) UK votes out, Scots leave uk, Tories disintegrate , Corbyn becomes pm. (2) what happens if it’s no? Is there any chance of a major split in the torys with a substantial part of the anti Europe faction going to ukip? Why don’t the anti EU hobbyists go to ukip as is? (3) has anyone done up a detailed speculation on the economic consequences of an eu exit? We had this with grexit and the Scots vote, mainly speculation and motivated reasoning depending on a person’s politics,. Is this all that’s possible in such a situation ? Surely educated guesses are possible.


Squarely Rooted 02.24.16 at 8:27 pm

I think a thermostat is a good metaphor.


Ronan(rf) 02.24.16 at 8:36 pm

Actually, to any potential respondents, ignore my brexit questions until later. I missed the *if you absolutely must* part, so I’ll wait for a more natural tangent to occur into brexit talk.


Keith 02.24.16 at 11:29 pm

A good metaphor is nice in a work of literature. Such as a poem.

But in technical subjects very dangerous, as always misleading unless the audience understands the subject. The big problem with economics is most people have no clue and that is exploited by unscrupulous politicians. Mainly right wing ones.

I for example think I understand gravity waves as I read about General relativity on Wikipedia after the announcement of their confirmation. But I cannot be certain as the Lorenz transformation and other maths is not easy to follow. Which is why it took Albert Einstein ten years to work it out. I am willing to take his word for it however. He also helpfully explains that Socialism is the answer to all other problems; always useful to quote that if needed!


marcel proust 02.25.16 at 12:06 am

Keith: How did you get this comment past moderation hell (purgatory)? My experience has been that the word you capitalized in your last sentence, “So******m”, causes comments on this blog to hang about in moderation until one has pleaded (in comments of course) with the poster, due to the word formed by the 6th through 8th letters of the longer word.


js. 02.25.16 at 1:40 am

The “socialism”/dick-drug thing hasn’t been an issue for several years.


marcel proust 02.25.16 at 1:56 am

Didn’t know that. Also, I, of course, meant, the word formed by the 3rd through 8th letters…


Tabasco 02.25.16 at 7:06 am

there are always one fewer exchange rates than there are countries

Actually, there are always one fewer exchange rates than there are currencies, which is less than the number of countries, since some countries have the same currency. Example: France, Germany, Italy, Netherlands etc all have the same currency, the Euro.


Socrates 02.25.16 at 8:09 am

+ the bold ignorance continues


reason 02.25.16 at 8:19 am

“or whether it would be good for the UK if the Chinese yuan appreciated”

For the “UK”? The whole point about exchange rate movement is that they favour some people and hurt others. Yet another case of an inappropriate collective (which seems to be the #1 logical error in political rhetoric).


chris y 02.25.16 at 12:09 pm

I think a thermostat is a good metaphor.

A thermostat has a setting that you can control exactly. Even if your central bank has a target exchange rate against some other currency, it may not be able to maintain it.


Pete 02.25.16 at 12:30 pm

Actually I’ve just realised that there’s a good analogy with weather: pressure.

Absolute pressure doesn’t matter much, and always returns to average, but changes in pressure come in “fronts” bringing warm or cold weather with them. Sufficiently dramatic changes produce damaging weather like hurricanes. So the currency dropping on bad news is an “exchange rate front”: weather blowing in that causes short term disruption.


Pete 02.25.16 at 12:37 pm

(Speaking of metaphors and analogies, I’m currently working on trying to liken the disadvantages of the EU free movements of goods/capital/labour to the sinking of the MV Herald of Free Enterprise due to water sloshing about the car deck …)


Placeholder 02.25.16 at 1:25 pm

With regards to @P. O’ Neill, et al., am I wrong in thinking the real objection is the way calling exchange rates a country’s “share price” is the way it lets capitalization wear the crown of patriotism and to falsely naturalize the belief that what is good for capital is good the economy? The blood sugar analogy is an attempt to move the emphasis from “high” to “stable”… does the weather analogy tell people “it is best that it has alternating periods of cheapness and dearness”, to worry if it doesn’t change (but regularly)? Even if it tries to awaken people from capital-fundamentalism will it make people look to good indicators?

@A H: Do companies depress dividend payments to increase sales? It depends on the metaphor you want I guess, but the problem is that’s not what people take from ‘share price of our America, Inc.’ because they also don’t know how that actually works. The ‘smartest guys in the room’ sure know, but…

It is after all so much easier to sell a tariff than a currency devaluation to the economic patriot.
But if a national currency is the right to buy stuff in a country isn’t the exchange rate is the just price of buying that right? So some countries have low exchange rates because they want to export. When the Chinese do it it’s called ‘dumping’ isn’t it? In contrast, Japan’s industrial policy wonks have got people to call an overpriced currency endaka fukyo, an ‘expensive yen recession’.

In short, we call it a ‘weak pound’; Do we need to call it anything more metaphorical than ‘cheap money’?

@Ronan, speaking of Indyref, rather than Brexit, I have been experimenting with the word ‘petrocurrency’ to convince the English that Scotland leaving is a good thing in a way that the pound sliding is also good. It doesn’t work.

@Pete, I feel like the anglosphere hasn’t discussed the “current account deficit” seriously since they called it the “balance of payments”.


Dick Veldkamp 02.25.16 at 1:50 pm

Actually the number of exchange rates for N currencies is N*(N-1)/2 (the number of different pairs). However the number of independent rates is only N-1, as stated.


Steven Kyle 02.25.16 at 4:28 pm

There is something missing in the above comments. Exchange rates should in the LR move toward the relative prices of goods IN INTERNATIONAL TRADE. It is entirely possible to have a country that is quite rich in material terms but which does not trade much internationally. Its currency might be weak because nobody wants it since there is nothing to buy with it. The people in this country might nevertheless all be eating three square meals a day, dress well, have great health care and schools, and a wonderful cultural life shared by all.

There is an inherent fallacy in imagining that the “share price” of a country is only high when that country sells stuff that foreigners want to buy. It aint so.


Trader Joe 02.25.16 at 4:50 pm

Can you think of an actual example of a country like that which actually has a floating currency? Usually when a country finds itself in something like the situation describe they adopt a currency peg or at least a floating peg (Hungary and Poland immediately post soviet union did this). In such case the peg holds until either demand for weak currency improves due to underlying economic strengthening or the peg currency weakens. Maybe I’m misunderstanding your point.


harry b 02.25.16 at 5:14 pm

You can only control a thermostat exactly as long as you have enough fuel.


harry b 02.25.16 at 5:15 pm

Well.. now I read that sentence it doesn’t seem right, but you know what I mean.


TheSophist 02.25.16 at 5:30 pm

As noted above, the fundamental problem with the share price metaphor is that it’s generally agreed that higher share prices are better (or at least that higher prices are the goal – there’s never been a CEO who said “if we all work really hard we can cut the share price by 20% this year”) but that’s not true w/r/t currencies.

One of Matt Yglesias’ more useful thoughts was that the strong/weak language used of currencies was problematic because of the natural assumption that strong is better. Whenever I teach this stuff, I always have the class work through a number of examples to see how exchange rate fluctuations impact various groups. The class is always surprised to find the many (including such examples as “my friend who owns a B&B in South Dakota”) who benefit from a weaker dollar.


Lupita 02.25.16 at 6:09 pm

“Can you think of an actual example of a country like that which actually has a floating currency?”

The US? It imports much less than it exports. Despite that, people eat and dress well. Schools are so-so for a wealthy country, which is good. As to a wonderful cultural life, maybe if you include video games and Netflix? Then there’s health care. Well, let’s leave it at four out of five.


Trader Joe 02.25.16 at 6:35 pm

I think you’re reading the challenge incorrectly. The US is blessed to have the reserve currency for every commodity on the planet and has issued a monetary supply that dwarfs all others. They may export less than they import but the total value of trade that is conducted in dollars is orders of magnitude higher than everything save the Euro and the Yuan. Indeed one could argue its the only currency that is always desired regardless of strength.

I’m not sure there is an example unless its something like the Uzbeckistani Som which is a massively weak currency, but it hardly matters since business is readily conducted in dollars or rubles.


Antoni Jaume 02.25.16 at 7:54 pm

You may have a malicious plugin that redirect to some “” site. On mobile it does not allow me to bypass it, for now. Please check as it might ffect other people.


hix 02.25.16 at 9:23 pm

Ive had a similar issue as Antoni


hix 02.25.16 at 9:24 pm

Just on my kindle, nothing on the win 7 laptop.


reason 02.26.16 at 9:08 am

Lupita @35
“The US? It imports much less than it exports. Despite that, people eat and dress well. Schools are so-so for a wealthy country, which is good. As to a wonderful cultural life, maybe if you include video games and Netflix? Then there’s health care. Well, let’s leave it at four out of five.”

It imports much less than it exports? Do you mean dollars or goods and services?


chris y 02.26.16 at 12:21 pm

I too hit the same prolem as Antoni and hix


Lupita 02.26.16 at 2:37 pm


I meant goods and services. Even if Trump were to win, take protectionist measures, start charging allies for military services, and crash the dollar, the US could still maintain a high standard of living. As Steven Kyle noted, a nation does not necessarily have to export a lot and have a strong currency in order to have a high quality of life. Neither does it necessarily have to be a world hegemon with the world’s reserve currency. Another world is possible.


Eli Rabett 02.27.16 at 12:44 am

there are always one fewer exchange rates than there are countries

Of course there is always gold and silver, and as somebunny above pointed out the Euro.

OTOH IEHO, the exchange rates are controlled by the relative return that investors calculate that they can get in the various currencies. Of course, besides interest rates they have to figure in inflation and sovereign risk. Right now Syrian pounds are not very attractive.


Metatone 02.27.16 at 10:31 am

Coming to this late, but I’ll add a vote for a thermostat in a house.
Not sure it’s better than blood sugar, but maybe it’s clearer that “right level”/”chosen level” isn’t as freighted with moral judgements (unlike diabetes/obesity).

As for the “share price” metaphor, definitely dangerous, there’s already a strong existing tendency (from the 1970s?) to view a strong pound as inherently a good thing.


PaulB 02.27.16 at 9:42 pm

It is meaningful to speak of share prices as ratios. For example, suppose I own shares in a Swiss Bank with a global business. If the Swiss Franc falls, the Swiss Franc value of the Bank’s global income will rise, so the share price goes up. But that isn’t good news for me in the UK: other things being equal the sterling value of my shareholding will fall.

Perhaps more relevantly, look at what happens in a stock split, or a successful rights issue. The share price falls, but that’s not bad news for the company. There’s an analogy to the effect on FX rates of expansionary monetary policy.


reason 02.28.16 at 4:51 pm

the US imports much MORE than it exports, and has done so for a long time (i.e. you had it 100% wrong). It can do that because the rest of the world likes to hold dollar denominated assets. This tends to push down US manufacturing wages, so it is not a good thing for all Americans (although it is good for some because it makes imports cheaper).


Lupita 02.28.16 at 11:43 pm


You’re right. I got exports and imports 100% backwards and dyslexically wrong. Perdón.


Edward Morbius 02.29.16 at 9:20 pm

Daniel Davies is correct to reject international exchange rates as some sort of national share price, though I don’t entirely agree with his logic.

First: monetary prices are themselves ratios, namely of the share of goods per unit currency, or vice versa, e.g., litres per pence, dollars per pound, dozen per Euro, etc. The specific ratio depends on the (market) valuation of the good, and of the currency.

Bartered exchange would reveal an underlying price in terms of ratios: oranges/apple, plumbing services / yard of cloth, etc.

So yes, international exchanges are ratios, because prices are ratios.

But they’re not stock prices. On several grounds. One is that national (or other) currencies aren’t a metric of the relative future prospects of nations / central banks, but of expectations of control over currency in future. Relative to market demand.

There’s also the slight hitch that joint stock corporations don’t engage in trade in terms of their own stock. While I may, say, buy shares in Tesco, I don’t have to tender them in exchange for my groceries whilst shopping there. Or Volkswagen, or Daimler, or British Airways. Corporations only rarely broker their own trade in terms of stock. Most often when buying or trading one another (e.g., a cash+stock swap in a corporate buyout), far more rarely in exchange for goods or services (usually limited to cash-starved start-ups). Though making this the case might be an interesting thought experiment.

As for role of money — blood sugar strikes me as the wrong metaphor, though it’s close. The main problem I have is that sugar is itself a factor of production. Money isn’t, it’s an information flow (literally: “pricing signal”). Biological analouges might be hormones or electrolyte balances which themselves mediate the exchange of nutrients, uptake of waste products, and overall levels of metabolic activity. Analogs on a broader sense, between individuals in a population, or of populations or species (in ecology) are harder to establish. Arguably, economics is in this sense the development of mechanisms for external signalling of deficits and surpluses in exchange.

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