Topics 1 : History, Monetary, structure, Advantages and disadvantages
* Historical background which gave birth to the Forex market is made by the same milestones which compose the history of a broader international regime.
* Floating exchange rates are not the only possible monetary system. Over time, international monetary systems exhibit oscillation between fixed and free floating regimes. We may think that the prevailing system is a normal condition and is here to stay, but whether it is permanent or not is an interesting and open question which can affect your trading carrer.
* The global market structure and the main financial centers
* Other instruments besides the spot Forex
* Advantages and disadvantages of the Forex market.
What is an exchange rate? An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of one country's currency compared to that of another. When traveling abroad you need to "buy" the local currency. Just like the price of any asset, the exchange rate is the price at which you can buy that currency.
Foreign exchange market
You don't have to be a trader to participate in the foreign exchange market: every time you travel and need to exchange your currency into a foreign currency, you are participating in it.
It also happens when companies from different countries buy and sell goods and services across national borders which require payments in non-domestic currencies. Either way, importing or exporting, there is going to be a transaction which takes one currency being swapped for another.
Nevertheless, in order to trade actively in this market, you should know how it came to be. The current market's shape and conditions are relatively new in the large history of money and that is what you are going to learn in this first chapter.
Despite your curiosity to jump directly into the more practical knowledge, you should know that an understanding of the historical circumstances from which this market emerged will gear you up with more insight when it comes to plan your future business in FX trading.
What about a little historical background about the largest financial market in the world?
1. The Origins
The FOREX (FOReign EXchange) Market is a cash-bank market established in 1971 when the US went off the gold standard adopted in the 1930's. At that time the US had to drop the gold standard after the 1929 crash and the British Pound became the currency of choice and the world's currency.
There have been other times before in Western History when paper money could be exchanged for gold. Throughout most of the 19th century and up to the outbreak of WW1, the world was on so-called "Classical Gold Standard" with all major countries participating in it. A gold standard meant that the value of a local currency was fixed at a set exchange rate to gold ounces. This allowed unrestricted capital mobility as well as global stability in currencies and trade
The participating countries were required to observe some rules: for example, it was particularly important that no country would impose restrictions on the importation or exportation of gold as a commodity nor a payment method. This was a guarantee for a free capital mobility based on supply and demand conditions.
Under this model, in which most central banks backed their paper money with gold, the currencies were supposed to enter in a new phase of stability, without the danger of an arbitrary manipulation of its value to increase inflation.
During the interwar period the world powers tried to return to the gold standard at the exchange rates previous to 1914, which seemed to offer prosperity and stability, but the attempt did not succeed and exchange rates ended mostly floating. The classical gold standard was shattered by the outbreak end of WWI and collapsed under its violence. Private trade and financial transactions were suspended, gold exports were banned, and each country started to print money to finance the war effort. The 1920s-30s were characterized by recessions and the Great Depression. There was a hegemonic power shift from the UK to the US.
After WWII the system became a US-centered fixed rates under a new international gold standard and the world economy experienced high growth, price stability and movement toward freer trade. Unlike the classical gold standard days, however, there were severe restrictions on private capital mobility.
The gold standard had its inefficiencies the way it was handled: the combination of a greater supply of paper money without the gold to back it led to devastating inflation and resulted in political instability.
The problem with gold is that its quantity is too constraining: the world supply of gold was insufficient to make the Bretton Woods system workable -particularly as the use of the Dollar as a reserve currency was essential to create the required international liquidity to sustain world trade and growth. As economies grew stronger and needed more money to pay imported goods, there was no sufficient gold reserves to pay for it. As a result the monetary mass decreased, the interest rates increased and the economic activity slowed down and the economy entered in a recession.
In such cases, the low prices of manufactured goods were then attractive for other nations. These started to import massively and by doing so they contributed to the increase of the monetary mass in the exporting country. This, in turn, allowed to ease the interest rates and subsequently the economy to grow. It was evident that the mechanism linking inflation/deflation with gold flows was not able to adjust macroeconomic imbalances. It was thought that under a gold standard, a country with a current account deficit would imply an outflow of gold. The loss of gold means less money supply, so the country would experience a price deflation. This would make its goods become cheaper in the global markets, making imports rise and exports fall, improving the current account again.
These peak-bottom periods alternated until the WWI interrupted the commercial flow and the gold exchange. Until WWII, currency speculation was almost inexistent and even not very much favored by institutions. The Great Depression and the abolition of the gold standard in 1931 led to a pause in the exchange activity. But later, after the transition period of 1971-73, the market suffered a series of changes which shaped the actual global monetary system: the major currencies started to float.
The Bretton Woods Era
After WWII the world needed a stable currency and a monetary agreement was reached by July 1944: seven hundred and thirty delegates from forty-four allied nations came together in Bretton Woods, NH, US The reason for the gathering was the United Nations Monetary and Financial Conference. For the first time in history monetary relations amongst the world's major industrial states were governed; it was the first time a system was implemented, in which the rules for commercial and financial relations were negotiated and agreed upon.
conference
It is said that many political reasons ended up resulting in the Bretton Woods agreement. Just to name a few: the two world wars and the interwar years, which was followed by the need to rebuild international economy; the Great Depression; the strong and shared belief in capitalism; USA.'s status of dominant power; the need for an economic system that would act as security.
Pegged, Semi-Pegged And Floating Condition
Considering the outcome of floating rates in the 1930's, which had negative worldwide consequences, the participants of the conference were eager to adopt basic rules with which to regulate the international monetary system as well as to create a policy in which the exchange rate of each currency would have a fixed value.
And indeed such measures were implemented: new international institutions were established to promote foreign trade and to maintain the monetary stability of the global economy.
The Bretton Woods system was an effective system that controlled conflict for many years. It could achieve the common goals that were set, however, its lifespan was finally short as by 1971 it collapsed.
It was also agreed that currencies would once again be fixed, or pegged, but this time to the US Dollar, which in turn was pegged to gold at 35 USD per fine ounces of gold. This meant that the value of a currency was directly linked to the value of the US Dollar. At that time if you needed to buy British Pounds, the value of the Pound would be expressed in US Dollars, whose value in turn was determined by the value of gold. If a country needed to readjust the value of its currency, it could approach the IMF to change the pegged value of its currency.
washington_hotel
Mount Washington Hotel, in Bretton Woods, New Hampshire, where in 1944, the United Nations Monetary and Financial Conference was celebrated, gathering representatives of 44 countries.
The peg was maintained until 1971 when the US Dollar could no longer hold the value of the pegged rate. From then on major governments adopted a floating system and all attempts from major economies to move back to a peg were eventually abandoned.
The Bretton Woods agreement was also meant to accomplish several other purposes: to avoid the capital evasion between nations, to restrict speculation with currencies, and to prevent each country from pursuing selfish policies, such as competitive devaluation, protectionism and forming trade blocks More generally speaking, to create a new world economic order. In fact, this new model brought two main advantages to the US: in on hand the revenues from the money creation itself calledseigniorage and on the other hand the possibility to hold a trade deficit for a very long time.
John Maynard Keynes, chairman of the Bank Commission at the Bretton Woods conference, and one of its intellectual founding fathers, envisaged an international monetary clearing union that in reality would have been a world central bank creating and using a world currency he called 'bancor'.
The problem, as Keynes well understood, was that an international trade and payments system - that relied on flexible exchange rates system with multiple currencies - would be inherently unstable. Keynes' proposal for a clearing union would penalize both deficit and surplus countries. Each country would have an official account in this mechanism, and all balance of payments surpluses and deficits would be recorded and settled through these accounts. There would be an incentive for both types of economies to run balanced trading systems as each country would bear the responsibility for correcting its imbalance.
This truly visionary proposal to create a mighty settlement union for all countries was seen as negative from US point of view.
Keynes' plan was not fully adopted but, in recognition of the pragmatic validity of his proposed solution, the exchange rates were fixed relative to the US Dollar and the Dollar backed by gold reserves. All other currencies could not deviate more than 10% to both sides of the fixed rate.
The US proposal, which was finally adopted, meant that each country would contribute to a common fund and member countries with surplus or deficit imbalances would have to purchase hard currencies from this fund. At the time, the UK was a deficit country and the US a surplus country, and only deficit countries would bear the responsibility for correcting the imbalance.
In case of such a fundamental imbalance, the central bank responsible of the currency had to ask authorization to the International Monetary Fund (IMF) to bring the value of its currency back to accepted levels. The IMF and what has evolved to be today the World Bank, the International Bank for Reconstruction and Development, emerged at that time to administer the new system.
At this point let's summarize the main features of the Bretton Woods system:
* It's a Dollar-based world payments arrangement: officially, the Bretton Woods system was a gold-based system which worked symmetrically for all countries. But in reality, it was a US-dominated system, which means the US provided domestic price stability (or instability) that other countries could (or should) "import". As the US did not itself engage in exchange rates intervention, which would have been desirable, all other countries had the obligation to intervene themselves in the currency market to fix their exchange rates against the US Dollar.
* It was a semi-pegged exchange rate system: this means that exchange rates were normally fixed but permitted to be infrequently adjusted under certain conditions. Members were obligated to declare a par value (a 'peg') for their national currency and to intervene in currency markets to limit exchange rate fluctuations within maximum 'band' of one per cent above or below parity. At the same time, members also retained the right, whenever necessary and in accordance with agreed procedures, to alter their peg to correct a 'fundamental disequilibrium' in their balance of payments. This arrangement was thought to combine exchange rate stability and flexibility, while avoiding mutually destructive devaluation.
* Tight capital mobility: by contrast to the classical gold standard of 1879-1914, when there was free capital mobility, member countries could impose capital-account regulations and severe exchange controls.
* Macroeconomic growth reached historically unprecedented highs: this was achieved through global price stability and trade liberalization from the mid 1950s to the late 1960s. page : 2, 3, 4, Market Structure, trade instrument , Advantages and Disadvantages,
* Historical background which gave birth to the Forex market is made by the same milestones which compose the history of a broader international regime.* Floating exchange rates are not the only possible monetary system. Over time, international monetary systems exhibit oscillation between fixed and free floating regimes. We may think that the prevailing system is a normal condition and is here to stay, but whether it is permanent or not is an interesting and open question which can affect your trading carrer.
* The global market structure and the main financial centers
* Other instruments besides the spot Forex
* Advantages and disadvantages of the Forex market.
What is an exchange rate? An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of one country's currency compared to that of another. When traveling abroad you need to "buy" the local currency. Just like the price of any asset, the exchange rate is the price at which you can buy that currency.
Foreign exchange market
You don't have to be a trader to participate in the foreign exchange market: every time you travel and need to exchange your currency into a foreign currency, you are participating in it.
It also happens when companies from different countries buy and sell goods and services across national borders which require payments in non-domestic currencies. Either way, importing or exporting, there is going to be a transaction which takes one currency being swapped for another.
Nevertheless, in order to trade actively in this market, you should know how it came to be. The current market's shape and conditions are relatively new in the large history of money and that is what you are going to learn in this first chapter.
Despite your curiosity to jump directly into the more practical knowledge, you should know that an understanding of the historical circumstances from which this market emerged will gear you up with more insight when it comes to plan your future business in FX trading.
What about a little historical background about the largest financial market in the world?
1. The Origins
The FOREX (FOReign EXchange) Market is a cash-bank market established in 1971 when the US went off the gold standard adopted in the 1930's. At that time the US had to drop the gold standard after the 1929 crash and the British Pound became the currency of choice and the world's currency.
There have been other times before in Western History when paper money could be exchanged for gold. Throughout most of the 19th century and up to the outbreak of WW1, the world was on so-called "Classical Gold Standard" with all major countries participating in it. A gold standard meant that the value of a local currency was fixed at a set exchange rate to gold ounces. This allowed unrestricted capital mobility as well as global stability in currencies and trade
The participating countries were required to observe some rules: for example, it was particularly important that no country would impose restrictions on the importation or exportation of gold as a commodity nor a payment method. This was a guarantee for a free capital mobility based on supply and demand conditions.
Under this model, in which most central banks backed their paper money with gold, the currencies were supposed to enter in a new phase of stability, without the danger of an arbitrary manipulation of its value to increase inflation.
During the interwar period the world powers tried to return to the gold standard at the exchange rates previous to 1914, which seemed to offer prosperity and stability, but the attempt did not succeed and exchange rates ended mostly floating. The classical gold standard was shattered by the outbreak end of WWI and collapsed under its violence. Private trade and financial transactions were suspended, gold exports were banned, and each country started to print money to finance the war effort. The 1920s-30s were characterized by recessions and the Great Depression. There was a hegemonic power shift from the UK to the US.
After WWII the system became a US-centered fixed rates under a new international gold standard and the world economy experienced high growth, price stability and movement toward freer trade. Unlike the classical gold standard days, however, there were severe restrictions on private capital mobility.
The gold standard had its inefficiencies the way it was handled: the combination of a greater supply of paper money without the gold to back it led to devastating inflation and resulted in political instability.
The problem with gold is that its quantity is too constraining: the world supply of gold was insufficient to make the Bretton Woods system workable -particularly as the use of the Dollar as a reserve currency was essential to create the required international liquidity to sustain world trade and growth. As economies grew stronger and needed more money to pay imported goods, there was no sufficient gold reserves to pay for it. As a result the monetary mass decreased, the interest rates increased and the economic activity slowed down and the economy entered in a recession.
In such cases, the low prices of manufactured goods were then attractive for other nations. These started to import massively and by doing so they contributed to the increase of the monetary mass in the exporting country. This, in turn, allowed to ease the interest rates and subsequently the economy to grow. It was evident that the mechanism linking inflation/deflation with gold flows was not able to adjust macroeconomic imbalances. It was thought that under a gold standard, a country with a current account deficit would imply an outflow of gold. The loss of gold means less money supply, so the country would experience a price deflation. This would make its goods become cheaper in the global markets, making imports rise and exports fall, improving the current account again.
These peak-bottom periods alternated until the WWI interrupted the commercial flow and the gold exchange. Until WWII, currency speculation was almost inexistent and even not very much favored by institutions. The Great Depression and the abolition of the gold standard in 1931 led to a pause in the exchange activity. But later, after the transition period of 1971-73, the market suffered a series of changes which shaped the actual global monetary system: the major currencies started to float.
The Bretton Woods Era
After WWII the world needed a stable currency and a monetary agreement was reached by July 1944: seven hundred and thirty delegates from forty-four allied nations came together in Bretton Woods, NH, US The reason for the gathering was the United Nations Monetary and Financial Conference. For the first time in history monetary relations amongst the world's major industrial states were governed; it was the first time a system was implemented, in which the rules for commercial and financial relations were negotiated and agreed upon.
conference
It is said that many political reasons ended up resulting in the Bretton Woods agreement. Just to name a few: the two world wars and the interwar years, which was followed by the need to rebuild international economy; the Great Depression; the strong and shared belief in capitalism; USA.'s status of dominant power; the need for an economic system that would act as security.
Pegged, Semi-Pegged And Floating Condition
Considering the outcome of floating rates in the 1930's, which had negative worldwide consequences, the participants of the conference were eager to adopt basic rules with which to regulate the international monetary system as well as to create a policy in which the exchange rate of each currency would have a fixed value.
And indeed such measures were implemented: new international institutions were established to promote foreign trade and to maintain the monetary stability of the global economy.
The Bretton Woods system was an effective system that controlled conflict for many years. It could achieve the common goals that were set, however, its lifespan was finally short as by 1971 it collapsed.
It was also agreed that currencies would once again be fixed, or pegged, but this time to the US Dollar, which in turn was pegged to gold at 35 USD per fine ounces of gold. This meant that the value of a currency was directly linked to the value of the US Dollar. At that time if you needed to buy British Pounds, the value of the Pound would be expressed in US Dollars, whose value in turn was determined by the value of gold. If a country needed to readjust the value of its currency, it could approach the IMF to change the pegged value of its currency.
washington_hotel
Mount Washington Hotel, in Bretton Woods, New Hampshire, where in 1944, the United Nations Monetary and Financial Conference was celebrated, gathering representatives of 44 countries.
The peg was maintained until 1971 when the US Dollar could no longer hold the value of the pegged rate. From then on major governments adopted a floating system and all attempts from major economies to move back to a peg were eventually abandoned.
The Bretton Woods agreement was also meant to accomplish several other purposes: to avoid the capital evasion between nations, to restrict speculation with currencies, and to prevent each country from pursuing selfish policies, such as competitive devaluation, protectionism and forming trade blocks More generally speaking, to create a new world economic order. In fact, this new model brought two main advantages to the US: in on hand the revenues from the money creation itself calledseigniorage and on the other hand the possibility to hold a trade deficit for a very long time.
John Maynard Keynes, chairman of the Bank Commission at the Bretton Woods conference, and one of its intellectual founding fathers, envisaged an international monetary clearing union that in reality would have been a world central bank creating and using a world currency he called 'bancor'.
The problem, as Keynes well understood, was that an international trade and payments system - that relied on flexible exchange rates system with multiple currencies - would be inherently unstable. Keynes' proposal for a clearing union would penalize both deficit and surplus countries. Each country would have an official account in this mechanism, and all balance of payments surpluses and deficits would be recorded and settled through these accounts. There would be an incentive for both types of economies to run balanced trading systems as each country would bear the responsibility for correcting its imbalance.
This truly visionary proposal to create a mighty settlement union for all countries was seen as negative from US point of view.
Keynes' plan was not fully adopted but, in recognition of the pragmatic validity of his proposed solution, the exchange rates were fixed relative to the US Dollar and the Dollar backed by gold reserves. All other currencies could not deviate more than 10% to both sides of the fixed rate.
The US proposal, which was finally adopted, meant that each country would contribute to a common fund and member countries with surplus or deficit imbalances would have to purchase hard currencies from this fund. At the time, the UK was a deficit country and the US a surplus country, and only deficit countries would bear the responsibility for correcting the imbalance.
In case of such a fundamental imbalance, the central bank responsible of the currency had to ask authorization to the International Monetary Fund (IMF) to bring the value of its currency back to accepted levels. The IMF and what has evolved to be today the World Bank, the International Bank for Reconstruction and Development, emerged at that time to administer the new system.
At this point let's summarize the main features of the Bretton Woods system:
* It's a Dollar-based world payments arrangement: officially, the Bretton Woods system was a gold-based system which worked symmetrically for all countries. But in reality, it was a US-dominated system, which means the US provided domestic price stability (or instability) that other countries could (or should) "import". As the US did not itself engage in exchange rates intervention, which would have been desirable, all other countries had the obligation to intervene themselves in the currency market to fix their exchange rates against the US Dollar.
* It was a semi-pegged exchange rate system: this means that exchange rates were normally fixed but permitted to be infrequently adjusted under certain conditions. Members were obligated to declare a par value (a 'peg') for their national currency and to intervene in currency markets to limit exchange rate fluctuations within maximum 'band' of one per cent above or below parity. At the same time, members also retained the right, whenever necessary and in accordance with agreed procedures, to alter their peg to correct a 'fundamental disequilibrium' in their balance of payments. This arrangement was thought to combine exchange rate stability and flexibility, while avoiding mutually destructive devaluation.
* Tight capital mobility: by contrast to the classical gold standard of 1879-1914, when there was free capital mobility, member countries could impose capital-account regulations and severe exchange controls.
* Macroeconomic growth reached historically unprecedented highs: this was achieved through global price stability and trade liberalization from the mid 1950s to the late 1960s. page : 2, 3, 4, Market Structure, trade instrument , Advantages and Disadvantages,
Source: http://en.wikipedia.org,fxstreet.com