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The Foreign Exchange Market Essay

1280 words - 6 pages

The Foreign Exchange Market
Before the times of the foreign exchange market, the world depended on the gold standard to determine the value of goods and services. This paper will describe in more detail the gold standard, the positive and negative aspects of using the gold standard and in addition the paper will summarize the major functions of the world’s major foreign exchange markets.
The gold standard was a monetary system that many countries used in order to determine the value of domestic currencies in relation to a specific amount of gold. The value of money, bank deposit and notes were transformed into gold at the specific amount. Britain was the first country to adopt the gold ...view middle of the document...

The supply of domestic money increases.
2. The supply of merchandise decreases.
3. The demand for domestic money decreases.
4. The demand for merchandise increases.
Any combination of these four factors determines what the rate of inflation is. Therefore, as long as the supply and demand for gold did not change too quickly, the supply of currency remained stable.
The gold standard hindered countries from printing and distributing an overabundance of currency. When the supply of currency increases too quickly people want to trade currency for gold because gold has become in short supply where currency has become more abundant. For the reason that the gold standard set a system of fixed exchange rates, the only real currency throughout the countries that used it was gold.
The gold standard caused the foreign exchange market to remain relatively stable and is seen as one of the major benefits of the system; however it is the stability that the gold standard caused that is seen as one of the largest disadvantages also. Considering that the exchange rates were fixed, this did not allow the market to react to the changing conditions in countries (Moffatt, 2008). The Federal Reserve was bound to the stabilization limits that could be used and because of these dynamics countries would experience rigorous economic shocks. These economic shocks would cause the price of merchandise to be very unsteady in the short run. Because governments and economies that followed the gold standard did not have much discretion over financial policies, unemployment rates were higher during the gold standard period.
After the annihilation of the gold standard and the Bretton Woods System, economies were still in need of a monetary system that allowed countries to participate in foreign exchange. Therefore, markets were created specifically for this purpose. The largest foreign exchange markets in the world are found in London, New York, Tokyo, Hong Kong and Singapore. Almost every nation in the world has their own form of currency that can be used within the limits of their own country without difficulty. However, if any other foreign persons, corporations or governments want to conduct business outside of their own country there has to be a standardized method to do so, hence the reason for the need of the foreign exchange. Foreign exchange refers to transactions or shift of funds from the currency of one country to the currency of another. These exchanges can be in the form of cash, traveler’s checks, bank deposits, available funds on debit and credit cards or other claims.
The daily trades of funds that are performed in the foreign exchange are approximately one trillion U.S. dollars (Forex Capital, 2000). The foreign exchange market directly affects the equities, bonds, private properties, manufacturing and al other assets that are obtainable to foreign investors. The foreign exchange also has a major...

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