Foreign exchange 101

I continue to receive a steady stream of questions about the “best” ways to pay bills and get local cash when traveling outside the U.S. No wonder, since (1) the answers are complicated, (2) foreign exchange is a moving target, (3) a lot of people who should know are still poorly informed, and (4) many banks, credit cards, and local merchants are out to gouge you if they can.

Over the years, I’ve urged you to 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. Overall, those suggestions remain valid, but, to misquote Orwell, “some are more valid than others.” You still have to choose your plastic carefully to avoid being gouged.

As in my original reports, I’m answering the basic questions in two parts:

  • The covers the fundamentals of foreign exchange, with a few summary recommendations. Conclusions here should remain valid for some time.
  • The second provides 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.

How it works

Unless you’re a successful currency speculator, converting your 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 most retailers and intermediaries take a cut out of the transactions.

Let’s say you’re visiting Pangaea:

  • When you exchange U.S. cash or traveler’s checks for Pangaean simoleons at a bank, an independent “bureau de change,” or a hotel’s cashier office, the bank/bureau/cashier keeps the full difference between the “buy” rate (at which it buys your dollars from you in exchange for the simoleons) and the “sell” rate (at which it sells dollars to Pangaean tourists heading for the U.S.). Even among strong currencies, that difference often exceeds 10 percent. It really doesn’t matter whether you make the exchange in the U.S. before you leave or after you arrive in Pangaea, except that the differences between buy and sell rates vary at different locations.
  • When you use your bank debit (ATM) card at an ATM in Pangaea, the ATM doles out the simoleons; the owner of the Pangaean ATM may or may not add a fee. The international Cirrus (MasterCard) or Plus (Visa) network makes the actual exchange. It credits the Pangaean ATM owner, in simoleons, for the simoleons it doled out to you plus its local ATM fee, if any; it converts those simoleons to dollars at the current wholesale rate, adding a one percent conversion fee, and it debits the resulting dollar charge your credit-card account at your bank. Most U.S. banks add a foreign-withdrawal fee up to $5 for each foreign transaction, regardless of the amount.
  • When you use your MasterCard or Visa credit card for a purchase in Pangaea, the Pangaean merchant’s bank credits the merchant’s account (in simoleons), taking a cut for doing the credit deal; the Pangaean bank transmits the charge to the international MasterCard or Visa network, which executes the exchange (as above), transfers the billing in US dollars to your account at the bank that issued your credit card, and charges your bank the one percent conversion fee; your bank bills you and, in most cases, tacks on a surcharge to cover the one percent international fee plus up to two percent more for doing nothing—a pure gouge.
  • When you use an American Express card for a purchase in Pangaea, AmEx does the whole deal—it pays the merchant in simoleons, converts the charge to dollars, adds a fee of about two percent, and debits the dollar charge to your AmEx account. Diners Club, which formerly worked the way AmEx does, now works as a conventional MasterCard.
  • The latest wrinkle (and usually a gouge) is “dynamic conversion” of credit card purchases. It goes just like the credit card purchase above, except that the Pangaean merchant bills you in U.S. dollars rather than simoleons. The merchant decides what rate to use for the exchange, which can be very bad, and your bank adds its surcharge, anyhow, even though the charge remains in U.S. dollars throughout.

These comments apply strictly to exchange in countries that do not control their currencies. Exchange in controlled countries is an entirely different game—one I can’t begin to cover now.

The range of loss

Over the years, I’ve checked various conversion techniques, mainly in Europe. In general, this is what I found:

  • Purchases by credit card: You lose nothing with a few credit cards; one to three percent of the purchase value with other cards.
  • Currency withdrawals with a debit (ATM) card: You lose nothing with a very few debit cards; up to $5 per transaction with most cards.
  • Exchanging U.S. dollars or travelers checks for local currency: You lose a bit over five percent at the most competitive banks, up to seven percent at less competitive banks, eight to nine percent at U.S. airports, and up to nine percent at independent non-bank change offices.

Some basic strategies

Given the complexity of the situation, it’s hard to develop “one size fits all” recommendations. Still, here are a few good general approaches:

  • For credit card purchases, use a card issued by a bank that adds little or no surcharge to foreign billings. Among those banks are Capital One, USAA, and quite a few smaller banks and credit unions, and AmEx isn’t bad.
  • For cash, use a low-fee ATM card. If you’re heading for Australia, Britain, Canada, France, or Germany, you can use a debit card from Bank of America without any fees at ATMS owned by one large bank in each of those countries. You can use a Citi debit card at Citi-owned ATMs in lots of foreign countries, although Citi’s coverage is spotty in many places. Debit cards from quite a few smaller banks also allow no-fee or, at worst one percent fee, withdrawals from foreign ATMs.
  • Do not use a credit card for local-currency cash advances; do not use a debit (ATM) card to withdraw foreign currencies in small amounts.

Next week, I’ll provide more extensive comparisons for some of the largest banks and credit-card issuers.