How Economics Helps You Save Money When Traveling Internationally

The number of international travelers is soaring. Many travelers need different currency as they arrive in new countries.  In the past, travelers using an ATM, credit or debit card were simply charged for purchases and withdrawals in whatever currency the locals used.  For example, U.S. travelers to France were charged in Euros when they used their credit card in Paris.

Recently, instead of being simply charged in the local currency many travelers are being asked if they want to pay in their home currency.  Companies offering the service call it “dynamic currency conversion.”  For example, some U.S. travelers to France are now asked if they want to complete transactions in dollars.

The change is occurring because ATMs and credit card terminals now have the ability to check where a card was issued.  Then international travelers can be asked whether they want to use their home currency for their transactions.  The question seems innocuous, but agreeing to use your home currency in a foreign land can inflate the cost of every purchase.

International Tourism

How people pay for things and how much they have to pay to exchange money is becoming increasingly important.  A century ago international travel was only for the rich.  Today, international travel is relatively cheap and has recently exploded.  The United Nations estimates that in 2016 there were 1.2 billion international tourist arrivals.  This is 300 million more people than the number of arrivals in 2008.  That’s roughly the size of the US population.

A favorite modern complaint is about air travel.  However, the cost of flying long distances has never been less expensive or safer.  This encourages ever larger numbers of people to travel abroad.  To capitalize on this, financial businesses have invented new ways of separating travelers from their hard earned money.

Paying Abroad

Many tourists use a credit, debit or ATM card to pay for hotels, restaurants and tourist sites.  A complex international computer network checks if the card is valid for the transaction.  To pay for the network some banks and credit card companies charge customers a foreign transaction fee.

However, banks are now offering cards with no foreign transaction fees.  Also “free ATMs” are now popping up around the world.  How do banks earn money if they are giving their product away for no charge?

The answer is simple.  The foreign ATM or credit card company offering the “deal” actually gives you a foreign exchange rate that is worse than the one given by your bank.

I live in the U.S. and was recently in London’s Heathrow airport and needed money.  The airport ATM asked if I wanted my bank account debited in a fixed amount of US dollars.  Saying yes meant the ATM would determine my exchange rate and give me the rate displayed on the screen.

Saying no meant my bank would determine my exchange rate.  However, I would not know the rate until after the transaction happened and would only see the rate when I checked my bank account.  The question of what to do is not just faced by U.S. travelers.  At the ATM next to mine an Italian family was arguing over the same problem, except they were presented with a fixed Euro to British Pound exchange rate.

By saying yes the “free” ATM effectively would have charged me 3.5%.  It did this by giving me a worse exchange rate than my bank.  Having watched numerous travelers in these situations I notice most people confronted by the choice pick “yes, do the transaction in my home currency.”

Why do travelers pay more by accepting a worse exchange rate when they could simply say no?  The answer comes from economics.

Three Functions of Money

Economists consider any item as money if it performs three different functions; unit of account, store of value and medium of exchange.  Two out of three explain why so many international travelers act the way they do.

The first function of money is a unit of account, which is how people post and keep track of prices.  This function is why banks and credit card companies get people to agree to pay in the currency where they live, instead of using local money.

When people travel to a country with a different currency they often mentally keep track of their spending using their home currency.  Many travelers also mentally convert all prices from the local currency into their home currency.

When an ATM or credit card terminal asks if you want to pay for something in the currency you use as your unit of account, your brain says yes.  It is natural to want to keep track in a familiar currency.

Money also acts as a store of value.  Items used as money provide the ability to make purchases now, and also in the future.  At the end of a trip travelers not planning on returning to a country spend all their leftover money in airports buying things they don’t really want.  These travelers don’t want to hold onto foreign bills since they are not a store of value.  For the same reason, they prefer to think of being charged in their home currency when getting money from an ATM.

Money is also a medium of exchange, which is anything readily acceptable as payment to buy or sell goods and services.  This is why people have to convert money when they travel abroad.  In New York City, U.S. one-dollar bills are a medium of exchange.  Travelers can exchange these pieces of paper for food, drink or a ride on the subway.  However, those dollars are not a medium of exchange outside the U.S.

Waving a stack of U.S. one-dollar bills in Beijing gets you stares, not food or a subway ride since businesses want to exchange their services for Chinese Yuan’s.  Travelers have to convert money from one currency to another because they need a medium of exchange.

How to Save Money

When faced with an ATM or Credit Card machine that asks if you want to convert to your home currency I recommend you pick no, especially if you went to the pain and effort to ensure you have a card or bank with no extra foreign exchange fees.

While I suggest you say no, your natural inclination is to say yes because the machine is offering a choice that make you feel comfortable.  I understand what is going on and my body instinctively wants to pick the yes key.  People just naturally want to do transactions in their home country’s unit of account and want to use the type of money they consider a store of value.

There is one case where you should say yes.  Some people have ATM or credit cards that come with a very high foreign exchange fee.  If your card does, then saying yes might save you money even if you get a poor exchange rate.

There are many things to understand while traveling.  Just remember banks and credit card companies are in business to make a profit.  One way they make money is by understanding that people have a strong desire to simplify their life.  People want to think in familiar units of currency.  Don’t be fooled when asked if you want to complete a transaction using your home currency.  Using the local currency can save you money, making your next trip abroad less costly.

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