Importance of Foreign Exchange Essay Example | 724 Words

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Importance of Foreign Exchange Essay

Importance of Foreign Exchange Essay Example

WHAT IS THE FOREIGN EXCHANGE MARKET?

The foreign exchange markets are the original and oldest financial markets. They are the basis upon which the rest of the financial system exists and is traded. It is the largest and most influential market in the world today. The world’s largest security markets – the New York Stock Exchange, the Hong Kong Stock Exchange, and the Nasdaq have a daily trading volume of three hundred billion dollars.

According to the Bank of International Settlements, the Foreign Exchange Market has a daily trading volume of six and a half trillion dollars. This daily figure is worth more than all but two of the world’s largest economies – China and the United States.

THE ROLE OF GLOBALISATION

People today live in an increasingly globalized world. Today’s financial world implicates businesses that rely increasingly on larger, complex, and more delicate global supply chains.

People store more foreign foods than locally made foods in their pantries. People drive foreign cars and work at multinational corporations. A mere fifty years ago, none of this existed. People driving foreign motor vehicles and eating foreign foods were seen as a luxury but have since become unexceptional.

Global supply chains have become enormous– and by many, seen as unnecessary and overengineered. You may think a humble product – such as the iPhone – assembled in China – necessitates forty-three countries. It consists of batteries made from lithium in Brazil, semiconductors made in Taiwan, sand for the glass screens mined in the Netherlands, and boxes made in the Czech Republic – a list endless and inordinately complex – to be brought together to China for assembly. This process is repeated perpetually – for soft drinks, furniture, electronics, and Toyota Corollas.

Through all these many exchanges, people like the Czechs are not interested in being paid in US Dollars or Chinese Yuan but in their local currencies. The process is repeated daily to create this enormous demand and a secondary market that we call the Foreign Exchange Market.

THE SIZE AND INFLUENCE OF THE FOREIGN EXCHANGE MARKET 

The Foreign Exchange Market is an ancient system with roots in the times of the Babylonians. Still, it veritably truly is a surprisingly new system for its size, rising in the aftermath of the Second World War following the Bretton Woods Conference of July 1944. A total of forty-four countries met at this Conference, limited only to the Allies in World War Two.

The Conference established the International Monetary Fund and the World Bank, most importantly, created a fixed exchange rate backed by the price of gold. Unlike previous gold standards, the Conference only valued one currency – the US Dollar. Participating countries “pegged” their currencies to the US Dollar, meaning there was no real currency market but depended on a specific rate for a certain amount of gold, at 35 USD/ounce, irrespective of supply and demand. In defiance, when the US Dollar came under conjectural pressure, the negotiation was required to maintain the US Dollar’s peg to gold.

Knowing this, eight of the world’s largest central banks amalgamated to form the London Gold Pool to control the price of gold and stabilize the price of the US Dollar. Notwithstanding these efforts, in 1967, a run-on gold and the devaluation of the UK Pound Sterling against the US Dollar resulted in a 14.3% devaluation, despite efforts by the London Gold Pool and the Harold Wilson government at the time.

The London Gold Pool intervened in an expansive buyout of gold. Consequently, the cost of supporting the dollar with gold would be demonstrated to be insupportable politically and economically. The London Gold Pool collapsed in 1971, and President Richard Nixon took the United States off the Gold Standard. After gold began to climb higher and higher, he had been faced with either keeping the United States Dollar’s control on gold prices by selling more gold or taking the US off the Gold Standard. Now, countries began to float their currencies freely, without any gold link.

Now, currency was traded on an open market, with direct currency trading – without any gold link – but to supply and demand.

A CONCLUSION

Although a foreign exchange may be confusing, perplexing, and volatile in today’s global marketplace, there is a need for everyone to possess an understanding of the foreign exchange market, with its concepts and effects.

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