Running Head: WORLD FOREIGN CURRENCY EXCHANGE MARKETS

World Foreign Currency Exchange Markets 1

Running Head: WORLD FOREIGN CURRENCY EXCHANGE MARKETS

World Foreign Currency Exchange Markets

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Abstract

The world’s foreign currency exchange markets play the role of “matchmaker” in a way; helping money from one part of the world find a “partner” willing to accept it in another part of the world. Another way to look at what foreign exchange markets do is that they “translate” money from one country, like translators normally translate words, into money which businesses and others in a different country can use and accept. In this way, world foreign currency exchange markets help people in all different nations, with different banking and financial systems, cooperate and work together to conduct business and world trade.

World Foreign Currency Exchange Markets

Systems which often create and maintain the basic building blocks of society are the least well known by society. This is the situation with the world’s foreign currency exchange markets. The praise goes to the Presidents or Prime Ministers who change laws so business can enter their countries more easily or to the development of computer networks so people in India can work for employers in New York or London without leaving home. It is not normally the system that permits international trade or exchange, the foreign currency exchange markets, that are considered important or lauded for the work it does, yet, without this system, international trade and travel could not occur.

It is through the world’s foreign currency exchange markets that international trade and investment can be conducted. The world’s international foreign currency exchange markets provide a means or process through which people can interact and conduct business that without their services could not take place. Every nation in the world, or every economic bloc of nations in the world, and the businesses and governments in those nations, uses their own, unique currency to conduct the business of government and trade. Assuring that different currencies are accepted by, or acceptable to, nations is what the world’s foreign currency exchange markets do.

Of course, each country’s national currency is known to have value. However, currency from one nation is normally not valuable in other nations. Therefore, in order for international trade and exchange to occur there must be a system whereby individual nations’ currencies are made acceptable and valuableto other nations. Without such a system the international trade system of trade envisioned by Adam Smith that would create an efficient and vital economy for the world would be impossible (Raghavan). It is the job of the world’s foreign currency exchange markets to facilitate international trade (Raghavan).

Currency has value based on the unique economic, political, and financial reserves and realities of a nation. This is why the Untied States dollar has been “worth more” than other currencies for many years. National government, politics, and financial resources can change, however. Therefore, foreign currency exchange systems must be able to accommodate those changes to assure that the “value” of all currenciesis internationally valid and accepted. In this way, money, like gold, oil, corn, and wheat is a commodity that can be traded and priced depending on “market conditions” (Feiler Schilling).

The value of money is also set throughinternational trade or supply and demand. Oil in the Middle East and inexpensive labor in Asia will drive demand to trade with a nation and thereby affect the value of a nation’s currency. Foreign currency exchange and the price of currency is determined and conducted by the central or main banks of many nations, such as those of the United States’ Federal Reserve Bank and England’s Bank of London(Boileau). These banks establish the price of the world’s currencies, their “exchange rates” (Boileau).Exchange rates are set as central banks purchasecurrency “reserves”to meet the needs and demands of their government and business interests (Boileau). Also, central banks are where different national currencies are exchanged or traded for others (Boileau). Through these means central banks work together to determine the “price” of all currencies through their actions and to provide their governments, businesses, and financial industries with the currency they need to conduct business or perform their functions (Boileau).

Today foreign currency exchange systems use a “floating” exchange rate system (FRB New York). A floating exchange rate system means that prices for currencies are set by the world’s supply and demand for particular currencies (FRB New York). This floating exchange rate systemhas worked well for decades, but it is not the original system used to value currencies. Until well into the Twentieth Centurythe “gold standard” was used(FRB New York). The gold standard was a “fixed” system of exchange between nations where each nation’s central bank set the value/price of itsnation’s currency depending on how many ounces of gold each unit of the national currency (such as one Dollar, one Pound, one Peso, etc.) could buy (Bordo). For example, the United States fixed the price of gold at $20.67 per ouncein 1834 and Dollar remained at this price until 1933 (Bordo). Other nation’s central banks and governments, just like the United States, would also determine the fixed value of their currencies relative to how much of their individual currencies was needed to buy one ounce of gold.

This system allowed all of the world’s currenciesto have a fixedvalue that other nations and their businesses, financial systems, and governmentscould rely upon because the value of foreign currency was tied to a valuable resource, gold, whose worth was trusted and reliable. Those who accepted foreign currencies to conduct business or for other reasons could then easily covert that currency, at a known rate of exchange, into their own national currency.

This fixed system of exchangeworked well for many years due to its stability and the fact that it was universally trusted and understood(van Eeden). This system allowed people and businesses to trust they could conduct international trade becausethey could trust the value of gold even if not that of an international currency (FRB New York). The gold standard alsobrought stability to trade because exchange rates were rarely changed (FRB New York). However, one of the biggest weaknesses of the fixed gold standard is the fact that gold has a value, just as money does (Bordo).

Gold also costs money to produce, store, and keep safe and the gold standarddid not account forthis (Bordo). Thiscreated a situation in which every time a nation produced or purchased gold it spent more money to obtain or store the gold then the value the gold gave the nation (Bordo). Another problem was that gold is a finite source and, at some point, the system might not have enough gold available for purchase or trade (Bordo). If that occurred, the entire system of exchange could no longer survive and international exchanges would instantly cease, at a great cost to all nations.

The gold standardceased being usedwhen its limitations threatened to end international trade (FRB New York). The United Stateshad began importing more and more goods, which meant that foreign holdings of United States Dollars began to grow (FRB New York). Many nations began to worry that the country lacked enough gold reserves to be pay for all of the Dollars foreign banks and othersheld (FRB New York). These concerns forced President Nixon in 1971 to stop fixing the price of theDollar to gold (FRB New York). Because the Dollar in 1971 was the world’s most stable and trusted currency when it stopped using gold other nations decided to use the United States Dollar to value their currencies (FRB New York). Instead of using a fixed system, however, the world opted for a “floating exchange rate” system, which is the one the world uses today.

References

Boileau, M. (NA). The Foreign Exchange Market. Department of Economics, University of Colorado at Boulder. Retrieved October 22, 2008, from

Bordo, M.D. (NA). Gold Standard. The Concise Encyclopedia of Economics, the Library of Economics and Liberty. Retrieved October 22, 2008, from

Federal Reserve Bank of New York. (NA). The Basics of Foreign Trade and Exchange. Retrieved October 22, 2008, from

Feiler, K. & Schilling, T. (NA). Strong Dollar, Weak Dollar: Foreign Exchange Rates and the U.S. Economy. Federal Reserve Board of Chicago. Retrieved October 22, 2008, from

Raghavan, C. (NA). Negative Effects of Trade and Capital Market Liberalization. Retrieved October 22, 2008, from

van Eeden, P. (2005). The History of Money. Retrieved October 22, 2008, from