Forex System - It Enables International Trade And Commerce

By Author: Samantha Dale
Total Articles: 610
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In today’s world, where international trade is carried out in huge volumes, the Forex system is the backbone to its success. The Forex system is a global system of trading in foreign currencies so that a businessman from one country, say France, can pay for imports of goods or services from Malaysia in Malaysian Ringgits. The Forex system determines the exchange rate between the two currencies using a rather complicated but efficient system. The Forex market is simply humungous and every day, except on weekends, deals are struck to the tune of $4 trillion. It is by far the largest trading system in the world.

Surprisingly, for such large amounts of cash, the different governments of the world mostly keep their hands off this market and so the Forex system is largely unregulated and market forces determines the exchange rates. This may not be strictly true in the sense that central banks of some countries do intervene in the Forex market, to prevent their national currencies from fluctuating widely. Other than currency speculators, International Trade prefers that currency fluctuations are within acceptable limits. ...
... This minimizes business losses due to fluctuations in the value of currency after, the deal has been stuck.

Till the 70’s, the Forex system was regulated by the Bretton Woods system. Currencies were allowed only a controlled float within a narrow band. Slowly deregulation took place and developed economies let the market determine its own level. Developing countries could not take such a risk and though they eased the rules somewhat, the government kept control on the Forex system. As a thumb rule, developed economies with a stable political system would have a stable currency. In underdeveloped countries, with instability, the local currency could depreciate very fast. In recent times the classic example is Zimbabwe which suffered from hyper-inflation.

The Forex system works on limited access at different levels. The big league is the interbank market which consists of commercial banks and securities dealers. Here the difference between bid and ask prices are razor sharp. The difference in the fourth decimal place could mean millions of dollars lost or gained. Down the ladder the difference in bid and ask price keeps widening. The largest trading center in the world is London followed by New York. Hong Kong and Singapore are also important financial centers.

In a typical currency trade in the Forex system, Currencies are traded against each other and are called a currency pair. It is denoted by the three letter code as per ISO 4217. Therefore the quote USD/JPY 76.9460 would denote 1US$ = 76.9460 Japanese Yen. In the Forex system most currencies are quoted against the US dollar, since it is treated as the base currency, with some exceptions such as the British Pound, Australian Dollar, NZ Dollar and the Euro.

With so many factors that can cause currency fluctuations, to become an expert in the Forex system may take years. For an individual to trade in foreign currencies carries a huge risk and caution, not greed, should be the watchword. Remember, if President Obama sneezes, it is enough to cause a fluctuation in the US Dollar, which can cause the speculative position you took, to go down the tube. The Forex system has helped the world to become a “Global Village”.

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