Essay on "F/X Markets Today's Foreign Exchange"

Essay 4 pages (1262 words) Sources: 3 Style: APA

[EXCERPT] . . . .

F/X Markets

Today's foreign exchange market is among the most dynamic markets in the world. Whereas equities and fixed income securities trade on perhaps one or two exchanges, foreign exchange trading takes place on exchanges around the world. There are four main f/x exchanges -- New York, London, Tokyo, and Singapore. The securities exchanged -- the world's major currencies -- are the same in each of these markets. This means that currency trading is conducted twenty-four hours a day during the work week. Combine the multitude of market players with the small handful of free-floating currencies and the f/x market is the most liquid in the world.

The rise of the modern currency market essentially began with Bretton Woods, which began the end of the gold standard. The gold standard was officially eliminated which Bretton Woods ended. For the entire industrial age, the gold standard was the main determinant of currency value. The gold standard was adopted de facto in England in 1717, and most nations followed suit to some degree. The gold standard functioned by fixing the value of the nation's currency to the value of gold. As the value of gold fluctuated, so too did the value of the nation's currency. The gold standard was officially adopted in England in 1819. The United States began life under de facto gold standard, though it was officially bimetallic (the other being silver). Gold standard was officially adopted in the U.S. In 1900 as a result of the Gold Standard Act. (Bordo, no date).

From 1880 to 1914, the gold standard was in use in most of the world's major economies. The gold standard broke down as a result of World War I, as we can see from Germany's post-war hyperinflation. However, from 1925 to 1931 the gold standard was restored. However, the United Kingdom left the standard, a move soon followed by the United States.

Until that point, the underlying principle was that gold was a powerful store of wealth. Nations held their reserves in gold, and these reserves backed the currency. Each U.S. dollar during the gold standard years in essence entitled the holder to a certain amount of gold. By the time the UK dropped out of the gold standard, only the U.S. And the UK held stores of gold to back their currencies. Most countries held stores of dollars or pounds (Ibid).

The Bretton Woods system brought a version of the gold standard into play, with nations fixing the value of their currency to the value of gold, with room for movements of 1% plus or minus. The value was the "peg" and the flexibility was the "band." An interesting point relating directly to today's pro-gold standard argument is that one of the drivers behind Bretton Woods was the near-universal agreement that the free-float of currencies in the interwar period had discouraged trade, and encouraged destabilizing speculation and competitive depreciations (Cohen, no date).

The Bretton Woods system collapsed in 1971 when the United States unilaterally withdrew. Prior to that, almost 2/3 of America's gold reserves had been transferred to Europe, a reflection of the growing negative balance of payments. The U.S. had become unable to control the value of its own currencies, while other nations could by trading dollars. The collapse of the gold standard can be attributed to the fact that the system relied on the United States as a force of global economic stabilization. Yet with no external controls on U.S. policy, the economy of the U.S. began to destabilize as a consequence of Vietnam War expenses, taking the entire global monetary system with it (Ibid).

The gold standard had certain advantages and disadvantages. It provided a stable rate of exchange. The architects of Bretton Woods realized that a characteristic of free floats was instability, and… READ MORE

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