Foreign exchange 101, part one: Back to basics

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 Typical questions include, “Why not just pay cash in local currency with money withdrawn from the local ATM using an ATM cash card?”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.

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.
• [% 288725 | | 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.

Although quite a few governments formerly controlled exchange rates, exchange is now a free, unregulated market in most of the developed world. My comments apply strictly to exchange in countries that do not control their exchange rates. Exchange in controlled countries is an entirely different game—one I can’t begin to cover now.

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A look at the scoreboard

On my last trip to London, I ran a comparison of how many dollars you’d have to exchange to net 100 pounds in cash or a charge. Here’s what I found, using the various options, as adjusted for the current wholesale exchange rate of $1.77 per pound.

To charge a 100-pound purchase:

• $179 with a no-gouge MasterCard or Visa credit card
• $180 with an AmEx card
• $183-$184 with gouge MasterCard or Visa credit cards

For 100 pounds currency, using a debit (ATM) card at an ATM:

• $179 using a Bank of America ATM card at a Barclay’s Bank ATM or a Citibank ATM card at a Citibank branch in London
• $181-$185 using most other ATM cards at most London banks

For 100 pounds currency, exchanging U.S. dollar currency or travelers checks:

• $187 at Lloyd’s Bank
• $188 to buy a 100-pound travelers check in the U.S.
• $189 at Heathrow Airport
• $192 at Coutts Bank
• $193 at San Francisco Airport
• $196 at a typical London street “bureau de change”

Some basic game plans

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 does not add a surcharge to foreign billings. Among those banks are Capital One, USAA, and quite a few smaller banks and credit unions.
• 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.

Next week, I’ll provide more extensive tables of fees and charges from some of the largest banks and credit-card issuers.