Any entity or person from any country can join the market at any moment and influence it. For example, your currency exchange will influence exchange rates at the local bank; this local bank?s exchange business will influence a larger bank?s exchange rates from which the smaller bank takes the foreign currency from, and that larger bank is probably a market-maker ? one link of the whole market chain. It?doesn?t?really matter that your role is small, what is important is that it exists. Things were different some time ago.
Bretton Woods agreement
Before July 1944 the world currency system was different. It was based on the principal that a sum of money could buy you what it was worth in gold. Of course, not every country agreed to accept any currency in international exchange. The majority of money was not convertible into gold and was only used for internal payments in a country. Without having a noticeable influence on the world economy, these currencies were not convertible (?convert? meaning exchange).
Only the banknotes of certain large countries were convertible into gold: Great Britain (pound sterling) and the USA (US dollar). In order to buy something abroad, for example, gold, equipment or even Chinese fur-coats, a businessman or bank had to exchange their money into US dollars or pounds first.
The situation then changed. By July 1944, the Second World War had shattered the economies of most war participants except the USA, which had incurred the smallest relative losses. Countries had to decide how to reconstruct trading relationships between them and what they would be after the horrible war was over. Not long before the end of the war, representatives of 41 countries gathered together in Bretton Woods (a tiny city in the USA with a population today of 600 people) to discuss the reformation of the?traditional system of gold standards.
It is worth saying that by 1944 the USA had taken into possession two-thirds of the world?s gold reserves. Most likely that was the reason why the US dollar became the only reserve currency in the world after the Bretton Woods meeting. In other words, 41 countries confirmed that only gold could be more reliable than US dollars.
Additionally, in order to support international financial operations, the International Monetary Fund was created in 1944. This fund provided credits to participating countries when they needed to support their currency on a nominal basis (that is, not considering inflation). The US dollar and gold became the main payment means for these countries.
All World prices for gold were set in US dollars and banks who had joined the IMF got the opportunity to change US dollars to gold at a fixed rate. The USA government promised to keep the rate at the level of ?1 ounce of gold for 35 US dollars, plus-minus 1%? and to change dollars back to gold at this rate upon demand. All other countries fixed their national rates within the limits of 1% of the nominal and there were minimal fluctuations.
Exchange devaluation of a currency was available for participating countries, but only with IMF permission and could be not more than 10%. In?fact, no one sought devaluation of their currency. It was profitable for many countries to use US dollars as a reserve currency and not gold.?However, there were contradictions in the system of super-stable currency rates: whilst all dollars were to be ensured by real gold, at the same time more and more dollars were being printed as countries had started to trade more. Where would the US get enough gold to cover all potential demands for exchange of dollars to gold?
By the end of 1964 the amount of printed dollars was equal to the amount of gold bars in the USA and so the US currency reached its ?golden?ceiling?. By 1970 the problem became worse. US dollar reserves in other countries were three times bigger than the USA and ?golden ceiling?,?which meant dollars were uninsured pieces of paper. Naturally, people began to doubt that the USA could secure such an amount of dollars. The?most?skillful?countries asked the USA to change their dollars back to gold and that made the US gold reserve decrease by half (from 17.8 billion US dollars to 11.1 billion). The US government?wasn?t?stupid however. In the middle of the August of 1971, the US Federal Reserve System (the big?boss for all monetary affairs in the US) made the decision to stop changing dollars into gold for other countries at a fixed rate.
Jamaica Agreement,?new currency system and appearance of Forex
After the Bretton Woods system lost its power in?December 1971, the US dollar naturally devalued?and in reaction the price of gold rose. A Troy ounce?of gold cost 38 US dollars and a year later it cost?42.2 dollars. Japan and nearly all the European?countries decided to ignore the agreement and?left it in 1973, as they felt there was little support?for countries in trouble. At that very moment, the?system of fixed rates was dead and its place was?taken by an unpublished system of floating rates?with decisive interference from Central Banks.?In January 1976 in Kingston, Jamaica IMF participant countries gathered once again to sign a new?document to control international trading. The?meaning of this document can be summarized?in the following statements:
- Gold was no longer an equivalent to money?and there was no need for the ?golden cover? anymore. So gold gradually drifted to?the category of goods or raw materials. One?could buy any amount of gold in any country?and the US dollar exchange rate would have?nothing to do with it;
- Since that moment, countries became responsible for the destiny of their currency:?whether it should have floating, fixed or other limited rate;
- A new international currency SDR (Special drawing rights) was introduced. It was a type of absolute money of the IMF that existed in some special accounts of certain countries. Balances of these accounts corresponded with the contribution of a given country to the IMF;
- Central Banks of different countries were allowed to shape their own policy. So long, big IMF brother!
The Jamaican meeting was not only meant to bring joy to its participants but to mark the beginning of a new flexible system of international?trading which would help to make it more simple for new countries to adapt to the situation. Nevertheless, the US dollar remained the major?currency for all international payments. Why? Because the economy of of the US was the most stable among participating countries. The new?agreement had the effect of ?curing? the falling dollar. With no link to gold anymore, there was no reason for it to devalue. By 1985 the value of
The Jamaica Conference of 1976 is considered to be the real moment when the Forex market was born.
the US dollar had increased by three times.The other countries?didn?t?get any advantage out of the agreement except getting free tourist vouchers for their bureaucrats. The global situation had dramatically changed. Currencies had nothing to rely on except wise international trading and a high level of manufacturing. There were no such supporting things for most countries. Constant inflation, continuous currency speculation, the linking?of a national currency to foreign ones (as well as?to currency baskets and SDR) became normal?practice for the major part of most countries??economies.
Though development of Forex has not stopped?yet, the Jamaica Conference of 1976 is considered?to be the real moment when the Forex market?was born. Just after that meeting, people from?all over the world were allowed to participate in?speculative currency deals.
European currency system
Following this influential conference, European?governments came up with some ideas of their?own. In order to support the independence of their?economies, some western European countries?created their own currency system (that is, the?European Currency System) that was based on?the ECU (European Currency Unit). Each country?s part in the general basket was dependent?on its GNP (Gross National Product ? the summarized cost of all goods manufactured and?services made), on the level of commodity circulation and mutual crediting. Also, the ECU was?partially supplied with once traditional gold. The?maximum fluctuation of any European currency?rate was set at the level of 2.25% from the predetermined one (?central rate?) and the mutual?quotations were calculated in ECUs. As soon as?any currency approached 75% of the maximum?fluctuation of 2.25% special early compensatory?measures were taken.
While this system provided some stability, it was not ideal either. For example, Great Britain entered the ECS in 1990 but soon left just a few years later in 1992, because of the negative impact of the European system on the British currency. The stability of the European system was, in turn,?undermined by Britain?s exit. The European currency system had to increase the maximum level of fluctuation to the value of 15%.?In 1995, the ECU was replaced by the Euro. The new agreement was signed by 12 economically advanced countries. Since June 2002, the euro has become available for private consumption. By the end of 2007, the rate of the euro had increased by 50% against the US dollar. The European currency became desirable as a reserve currency just as much as the US dollar. Finally, the currency world had started to diversify.
The Forex market is the place where trading is conducted at market prices dictated by the law of supply and demand. There are exchange and overthe-counter (interbank, OTC) currency markets. Stock exchanges, such as the New York Stock Exchange, are hives of business activity, where traders work in one building (exchange house) and all day long the cries of ?Buy! Sell!?can be?heard. In contrast, the over-the-counter Forex?market is when traders sit at the office or even?at their apartments and use special software to?buy or sell currencies. Most Forex brokers will?allow you to deal through the interbank market.
In fact, there is no big difference between the currency markets and any other market. After consideration we find only two key differences:
- We typically think of markets as places where you can buy or sell products, such as fruits and vegetables at a farmers? market, but you deal with euros, US dollars and other currencies on the Forex market.
- The daily turnover of a typical city market is about $30,000 but in the Forex market, the daily turnover is about 3 trillion US dollars. And it?s not because cucumbers or tomatoes are cheaper than euros, it is the amount of market participants and their wealth that makes the Forex market so large.
Aside from the types of products and overall market size, there are few other significant differences between currency markets and other types of markets. One more difference that we should note, however, is utilization of advanced information technology. Financial markets use IT on a significant basis. For instance, our company Forex4you provides its customers with the modern trading software MetaTrader application,?which allows them to trade Forex all over the?world, either on their laptop or smartphone.?When you consider the above it becomes clear?why the famous billionaire George Soros (the?most successful trader in history) started his?foreign currency business, rather than the importing of oranges from Morocco.The biggest?currency markets are in the United States of?America, Great Britain, Germany, France, Switzerland, Japan and Singapore.
Now that we know what the over-the-counter market (Forex) is, it?s high time for us to study its peculiarities. In order to make this process easier we have divided the market into five major parts: Traders, Brokers, Accounts, Instruments and Orders. The modern Forex trading process works like this: a Trader applies to a Broker for an Account, afterwards he chooses his financial Instrument to trade and places his Order. As a second example, the market price for the Instrument increases and the Trader sells the Instrument, the Order makes a profit and the Broker enlarges the sum of money of the Trader?s Account. As you can see, any given market situation involves these five elements.?The order for the second example is Instrument ? Order ? Broker ? Account ? Trader, and comes closest to describing the world of Forex in this ebook. Every one of the five Forex ?pillars? mentioned above has its own features, nuances and associated terms, and will be explained in this document.