You earn €3,000 a month. Move from Helsinki to Lisbon and your salary might drop to €1,800. But your rent, groceries, and coffee all cost roughly half as much. Are you worse off? Maybe not.
This isn’t a trick. It’s the difference between what you earn and what you can buy with it (your purchasing power), and it depends on where you are.
What is an exchange rate?
An exchange rate is simply the price of one currency in terms of another. If the EUR/USD rate is 1.08, one euro buys you 1.08 US dollars.
Exchange rates change constantly. They’re driven by supply and demand, interest rate differences between countries, trade flows, speculation, and central bank policy. You don’t need to understand all of that. What matters is what exchange rates mean for your money.
Two things to remember:
- Exchange rates convert nominal amounts. They tell you how many dollars you get for your euros. They don’t tell you how much those dollars can buy
- Exchange rates fluctuate. The rate today may not be the rate next month. If you earn in one currency and spend in another, this matters a lot
Why the same amount buys different things in different countries
Here’s a simple test: how much does a cappuccino cost?
| City | Price of a Cappuccino |
|---|---|
| Helsinki | €4.50 |
| Berlin | €3.20 |
| Lisbon | €1.60 |
| Bangkok | €1.20 |
Same drink. Same basic ingredients. Very different prices. The reason isn’t that coffee beans cost more in Finland. It’s that wages, rents, taxes, and overall price levels differ across countries.
This is purchasing power parity (PPP) in action. PPP is the idea that, over time, exchange rates should adjust so that the same basket of goods costs the same everywhere. In practice, they don’t, and the gap is where things get interesting.
The Big Mac index: a rough guide
The Economist magazine has tracked this for decades using the Big Mac index. A Big Mac is roughly identical everywhere: same ingredients, same process. So if a Big Mac costs €5.50 in the eurozone and $5.70 in the US, and the exchange rate is 1.08, the implied PPP rate is 5.50/5.70 = 0.96. If the actual rate is different, one currency might be over- or undervalued.
It’s not precise. But it illustrates the principle: exchange rates don’t perfectly reflect what money can actually buy.
What this means for you
If you live and earn in one country
PPP mostly affects you when you travel. Your euros go further in countries with lower price levels. A holiday in Portugal costs less than a holiday in Denmark, even at the same exchange rate.
If you earn in one currency and spend in another
This is where exchange rates become personal. If you earn in euros but have expenses in British pounds (mortgage in the UK, family abroad), exchange rate movements directly change your real income. A 10% swing in EUR/GBP can add or subtract hundreds from your monthly budget.
If you’re considering moving countries
A salary cut doesn’t necessarily mean a lower standard of living. What matters is your real income: salary adjusted for local prices, the same gap between what you earn and what it actually does for you that drives wealth at home. €2,000 in Lisbon might give you the same lifestyle as €4,000 in Copenhagen.
Two types of currency risk
When your money crosses borders, you face two risks:
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Transaction risk: The exchange rate changes between when you agree to a price and when you actually pay. If you’re buying something online in USD and the euro weakens before your payment clears, you pay more euros than you expected
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Living-cost risk: If you earn in one currency and spend in another, your cost of living changes every time the exchange rate moves. This is ongoing and unpredictable
Both are real. Both can be managed, but only if you’re aware of them.
Common misconceptions
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“A strong currency means a richer country.” Not necessarily. A strong currency makes imports cheaper but exports more expensive. Japan has a historically “weak” yen relative to the dollar, but Japanese purchasing power within Japan is high
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“PPP means exchange rates should be equal.” PPP doesn’t say the exchange rate should be 1:1. It says the exchange rate should reflect what money can buy. The actual rate can differ from PPP for long periods due to trade barriers, productivity differences, and capital flows
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“You should always convert to the cheapest currency.” Conversion has costs: fees, spread, timing risk. Chasing the best rate on every transaction usually costs more than it saves
What you can do
- Think in real terms, not nominal. A salary number means nothing without knowing what it buys locally
- Know your exposure. If all your income and expenses are in one currency, exchange rates matter less. If they’re not, know exactly which currencies you’re exposed to
- Over-optimizing on exchange rates rarely pays. Currency moves are hard to predict, so trying to time conversions usually costs more than it saves; many people convert when they need to
- Account for PPP in major decisions. Comparing job offers across countries? Adjust for local price levels first
Understanding exchange rates and PPP is the foundation for managing money across borders. Whether you’re comparing job offers in different countries, planning a move, or simply wondering why your holiday budget stretches further in some places than others, thinking in real terms instead of nominal ones is the skill that ties it all together.
In the previous post, we looked at how purchasing power erodes over time through inflation. Here, we’ve seen how it varies across space. Both forces shape what your money is actually worth, and both matter when you’re making decisions about where to live, work, and invest.
So we know that money loses value over time (inflation) and across borders (exchange rates). The next question is practical: what should you do about it? When should you save your money, and when should you invest it? They’re not the same thing, and getting the sequence right matters more than most people think.