The following paper discusses at length what Foreign exchange market is and how beneficial it is for world economics. The paper also discuses three major world currencies and how their fluctuation is affecting world economy. The current global economic condition requires one to understand the mechanisms of economy and how it affects the daily lives.
International Financial Markets
An institutional and physical structure is provided by the foreign exchange market. Through this procedure, currencies of different countries are exchanged. The final rate of exchange between currencies is calculated, and then the foreign exchange conversions are known to be physically completed.
In simple words, a foreign exchange conversion is a mutual agreement between the buyer party and the seller party for a given sum of one currency which is to be submitted at a specific rate for some other currency.
Geographically, there is no physical boundary, instead the market extends globally. Countries all over the world participate in foreign exchange markets, known as forex in short. A foreign exchange market can be free or restricted. Restrictions on the market vary from country to country.
Primary functions of Foreign Exchange Markets:
Facilitate buying and selling of good sand commodities: The basic purpose is to smoothen the procedure of buying and selling of credit in diverse countries. To purchase the products of a british company, an American firm will have to buy British currency, i.e. pounds so that it can make the payment for the purchased goods. If the American company chooses to pay in US dollars, the British firm exchanges the currency; they exchange US dollars for British Pounds.
Terms of credit for foreign trade: The foreign exchange markets make available money for foreign trade. Just Like other traders, world international trade also requires flow of money. Needless to mention, it takes time to shift the goods from supplier to customer and during this time, the contract must be financed. Credit is important for the transfer of goods only when the exporter does not demand money for the production of export goods. Till date there have been no particular institutions nominated for foreign exchange markets. It is a natural business approach which comprises of institutions such as governments, business organizations, central banks, investment management firms, remittance companies and money-transfer. (“What is foreign exchange market?”, 2)
Currencies and their Fluctuations
US Dollar: US Dollar is one of the most effective currencies in the world and its fluctuation affects the entire world markets. Recent economic recession has seen severe fluctuation of the US Dollar. There are varied reasons for the fluctuation of US Dollar in comparison with other currencies in the world. Usually the Dollar gains a high when the demand for Dollar for speculative as well as transactional reasons and alternatively weakens when the demand decreases.
Trade imbalance is the major reason for currency imbalances. Foreign investors seek US Dollar to buy US exports such goods and commodities and even securities. As the US exports become cheaper, foreign investments as well as imports become expensive which causes the US Dollar to weaken. Whereas with decline in rates of the imports and foreign assets, there is observed a proportional rise in exports and U.S. investments, and hence the dollar may grow with respect to other foreign currencies. Trade surpluses and deficits are also a major force behind the fluctuation of the Dollar. In the current scenario US is facing huge trade deficits with Southeast Asia, Japan, China and European Union.
Speculation is another important factor affecting the fluctuation of the Dollar. Fluctuating Dollar has many effects on the country as a strong Dollar helps to reinstate America as a superpower. It attracts more foreign investment and is helpful in mergers and acquisitions of US firms in the overseas markets.
Indian Rupee: With the exposure of overseas investors in India, a great level of stress and discomfort is being observed with the Indian currency. Fluctuations in Indian rupee completely vary with the market conditions. In order to maintain effectual exchange rates, the Reserve Bank of India (RBI) dynamically trades in the US$/INR currency market. There is also an intervention in the currency markets by the RBI to keep up low volatility and wipe out the excess liquidity from the economical market. (“The financial express, Rupee-dollar enigma.”, 3)
EURO and British Pound: Euro, the official currency of the Eurozone has been witness to great fluctuations caused due to the global financial crisis. The recent fluctuation of the British pound has had severe effects of the Eurozone. In the UK and in the Irish Republic, whose business cycles are usually comparable, the problems that followed the GFC were similar in nature and in severity. (“The Euro and its Antecedents.”, 6) In both the countries, the major banks as well as their depositors were saved from collapsing by their ruling governments. However, there has been a lot of difference in the macroeconomic outcomes. The Irish republic has demonstrated a much higher unemployment rate than the U.K. This is because an independent monetary policy is not possible in the Irish Republic, which is part of the euro zone. The effect of the GFC is that the Irish Republic now has an overvalued currency, which has made an inefficient economy more inefficient.. (“UK Trade performance: patterns in UK and global trade growth”, 7)
Work Cited:
1. Eiteman et al. (2004). The foreign exchange market. Retrieved from http://flash.lakeheadu.ca/~pgreg/assignments/4079chapter4n.pdf
2. Forex PDF (2011). What is foreign exchange market?. 10 January 2011. Retrieved from http://forexpdf.info/2011/01/what-is-foreign-exchange-market-who-are-its-participants-what-are-its-functions-pdf-forex/
3. Shah A. (2008). The financial express, Rupee-dollar enigma. 10 November 2008. Retrieved from http://www.financialexpress.com/news/rupeedollar-enigma/383426/
4. The independent financial portal, Financial Web (2011). Retrieved from http://www.finweb.com/investing/the-effects-of-us-dollar-fluctuations.html
5. Ickes B. (2009) The foreign exchange market. Retrieved from http://econ.la.psu.edu/~bickes/forex.pdf
6. Mushin J. (2010) The Euro and its Antecedents. 4 February 2010. Retrieved from http://econ.la.psu.edu/~bickes/forex.pdf
7. UK Trade performance: patterns in UK and global trade growth (2010). 13 November 2010. Retrieved from http://www.bis.gov.uk/assets/biscore/economics-and-statistics/docs/u/10-803-uk-trade-performance-growth-patterns
