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Foreign exchange 101, part one: Back to basics

AskEd & AnswerEd
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Editor's Note: This story was originally published on January 4, 2006. To see the most recent SmarterTravel articles on related topics, please click on any of the following links: AskEd & AnswerEd, Ed Perkins.

I get more questions about the "best" ways to arrange foreign exchange than about any other subject I cover. No wonder, since the question is (1) complicated and (2) a moving target, with constant shifts. Typical questions include, "Why not just pay cash in local currency with money withdrawn from the local ATM using an ATM cash card?" and, "Different credit cards charge very differently when converting currency rates. We will be leaving for Canada, and I would appreciate some advice."

Over the years, I've urged that you use plastic as much as possible: a credit card for big-ticket purchases, like hotel accommodations, restaurant meals, rental cars, local rail tickets, and such; and a debit card in an ATM for whatever local currency you need. While those suggestions are still valid, they no longer apply equally to all credit and debit cards. You have to choose your cards carefully to avoid being gouged.

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Given the complexity of the question, I'm answering the basic questions in two parts:

  • This week's report covers the basics of foreign exchange, with a few summary recommendations. Conclusions here should remain valid for some time.
  • Next week's report will provide detailed tables of rates and fees charged by individual banks. The data are accurate as of the last times I've checked, but those specific rates are the "moving target" mentioned earlier. Accordingly, I expect to update the tables as conditions change.

The foreign exchange game

Unless you're a successful currency speculator, converting U.S. dollars to some other country's currency is always a "no-win" game. At best, you can eke out a tie, but most of the time you lose. Your goal, then, is to lose as little as possible.

The "wholesale" costs of conversions among big financial institutions are extremely small—much less than one percent for major country currencies. But as an ordinary traveler, you pay retail, and the retailers and the intermediaries each get their cut.

Let's say you're heading to Paris for a week:

  • When you exchange U.S. cash or travelers checks for euros at a bank or an independent "bureau de change," the bank/bureau keeps the full difference between the "buy" rate (at which it buys your dollars in exchange for the euros) and the "sell" rate (at which it sells dollars in exchange for your euros). It really doesn't matter whether you make the exchange in the U.S. before you leave or after you arrive in Paris, except that markups at different locations can vary.
  • When you use your ATM card at an ATM in Paris, the ATM doles out the euros, while the owner of the Parisian ATM may or may not add a fee; the international network makes the conversion, adds its one-percent conversion fee, and debits your dollar account. Your own bank may or may not assess a fee up to $5 for each transaction.
  • When you use your MasterCard or Visa credit card for a purchase in Paris, (1) the Parisian merchant's bank credits the merchant's account (in euros), taking a cut for doing the credit deal, (2) the Parisian bank transmits the charge to the international MasterCard or Visa network, which actually executes the exchange and transfers the billing in U.S. dollars to the bank that issued your credit card, adding a one-percent fee that it charges your bank, and (3) your bank bills you and may or may not tack on a surcharge for the one-percent international fee and up to two percent more for doing nothing—a pure gouge.
  • The latest wrinkle (gouge?) is "Dynamic Conversion," which goes just like the credit card purchase above, except that the Parisian merchant bills you in U.S. dollars rather than euros, at whatever (unknown to you) exchange rate the merchant decides to charge.
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