The Economics of Foreign Exchange

The foreign exchange market is one of the most influential markets in the world, with a daily trading volume of around $6.6 trillion. It surpasses even the largest stock exchanges in terms of trading volume and plays a crucial role in global finance.

In today's globalized world, businesses rely on global supply chains to produce and provide products and services. Different countries specialize in different areas - China for cheap manufacturing, Germany for high-quality construction, Japan for the best seafood. This is a stark contrast from 100 years ago when local production was the norm.

Countries like Germany and China have different strengths in terms of production capabilities. While Germany has the infrastructure and technical expertise to produce iPhones, it has expensive labor, strict environmental regulations, and limited access to component suppliers. On the other hand, China excels in mass medium quality manufacturing with a larger low-skilled labor force, looser environmental regulations, and proximity to component factories. Instead of both countries trying to produce everything themselves inefficiently, they can specialize in what they do best: Germany making high-quality cars and China producing affordable phones. By trading their products based on their comparative advantage through currency exchange rather than direct bartering.

The Bretton Woods Conference and the Fixed Exchange Rate System In July of 1944, the Bretton Woods conference established a gold standard for currencies. It created guidelines for a fixed exchange rate system where participating countries pegged their currency to the US dollar. However, this system eventually collapsed in 1973 due to cracks and challenges.

Key Players in Foreign Exchange Trading: Businesses, Investors, and Governments "Businesses transfer money to foreign countries and convert it into local currency for operations. They face foreign exchange risk if currency values fluctuate unfavorably." "Investors use derivatives as financial instruments to bet on currency fluctuations with companies." "Governments manipulate their own currencies' value by buying or selling large amounts of foreign currencies."

The Value of the Pound Despite the turmoil surrounding Brexit, the pound remains the world's most expensive currency unit. Historically, currencies were tied to precious metals like gold and silver. Today, although these standards have been removed, some of the pound's value is still influenced by its past connection to sterling silver.

"Price" vs "Value" "Price" does not always reflect true value when it comes to shares and currencies. For example, a share in Amazon may cost less than a share in Seaboard Corporation but that doesn't mean Amazon is smaller or less valuable as a company. Currencies and shares do not have intrinsic value; their worth depends on what someone is willing to exchange for them.