One concept that has always been an essential factor in the definition of a country is the fact that it has its own currency. The concept of national coinage has been in existence ever since the world was divided into countries with national borders.
The United States has always used the dollar, the United Kingdom uses the pound, Germany had the Deutsche Mark, Japan uses the Yen, etc. Recently many European countries have adopted a single currency, the Euro which has obviously had an impact on the Forex market as we know it today.
Even though national coinage has been around for a long time, trading between different countries, i.e. the need of a foreign exchange rate, is a more recent phenomenon and has only really made a breakthrough during the course of the last century. It has rapidly grown into the huge market it is today, generally considered the most liquid market in the world.
Currencies form the core of the international monetary market. The foreign exchange rate is the value of one currency expressed in another, for example $1 = 0.76?. The exchange rate can therefore be seen as the price of a currency. Much like any other market price, it is determined by supply and demand. As supply and demand are constantly changing, exchange rates can fluctuate. These fluctuations are referred to as volatility.
Depreciation occurs when there is an increase in the supply or a drop in the demand of the currency in question. The opposite, an increase of the value of one currency compared to another is called appreciation. Appreciation occurs when there is a drop in the offer or an increase in the demand for the currency in question.
What factors determine supply and demand?
- International trade
An important factor is international trade and services. Imported goods and services are usually paid for in the currency of the exporting country. For example: An English distributor of American pharmaceuticals who wants to buy pharmaceutical products in the United States will have to change British Pounds into American dollars based on the daily exchange rate.
Sometimes international trade transactions are paid in a currency that is accepted worldwide but is not the currency of either of the countries involved in the transaction. This is called a key currency. The most important key currencies are the American dollar, the British pound and the Euro.
- Foreign investment
Products and services are sold and traded all over the world. Money in the form of investments does exactly the same thing. A distinction should be made here between foreign direct investments and portfolio investments, meaning the investment in shares. In the case of foreign direct investments the foreign investor is directly involved in the economy of the host country. Portfolio investments are purely financial transactions without the investor being able to exert any sort of direct influence on the economy of the host country.
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One thing is certain, the currency market is vast, very active and it will be around for a while. Definitely worth exploring!
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