F31 Foreign Exchange

Foreign exchange, also known as forex, is the conversion of one country's currency to

another. In a free-market economy, a country's currency is valued according to supply and

demand laws. Apparently, a currency's value can be determined in another country's

currency, such as the Indian rupee or the US dollar. The government can also determine the

value of a country's currency.

1. What is the importance of the field you have chosen?

Foreign exchange is an integral part of the world's financial system. Without it, many aspects

of our daily life which we take for granted would not exist. The foreign exchange facilitates

the cross-border movement of goods and services connecting the global economy. Foreign

exchange is necessary because it helps a country to pay its import bills towards imported

goods and services by its citizens or companies. When we import goods and services from

other foreign countries, we have to pay them in their local currency. In between, a transaction

has to occur that converts our currency into the currency of the producer. That transaction is

commenced in the foreign exchange market.

The foreign exchange market is the market in which currencies of different countries are

traded. It is here that buyers and sellers transact in other currencies in the same way as goods

and services are sold. The exchange rate of different currencies is determined here.

The exchange rate can help or hurt specific groups within a country. For e.g., A exporter

tends to gain more profit by a weak domestic currency because his goods would sell more

abroad. Simultaneously, consumers are hurt by a weak domestic currency because imported

goods would be more expensive for them and vice versa.

As a child and an adult, I always wondered how the currency's exchange rates are

determined, why the Indian rupee fell against the US dollar, and what the government can do

to strengthen the Indian rupee. The other thing that sparks up the curiosity in my mind to

know about the foreign exchange is that it's the largest global market, even more, significant

than the US Stock market. Conferring to the Bank for International Settlements triennial

report of 2016, the forex market cap averaged $5.1 trillion per day.

3. How has foreign exchange evolved? A bit of history.

The barter system is the most ancient method of exchange and began in 6000BC. Under it,

goods were exchanged for other goods. Eventually, the beginning of the 6th century BC

marked the production of the first gold coins, and they acted as a currency.

And in the 19th century, countries shifted to the gold standard. The gold standard guaranteed

that the government would exchange any amount of paper money for its gold value. This

worked fine until World War I when European countries had to suspend a gold standard to

print more money to compensate for the war.

The foreign exchange market was covered by the gold standard at that time and during the

early 20th century. Countries traded with each other because they could convert the currency

they received into gold. However, the gold standard did not last during the world wars.

The first significant transformation of the foreign exchange market, the Bretton Woods

System, occurred toward World War II. The US, France, and Great Britain met at the United

Nations Monetary and Financial Conference in Bretton Woods, New Hampshire (US), to

design a new global economic order.

exchange rate is an exchange rate policy that fixes one currency in another currency. In this

case, foreign countries would "fix" their exchange rate to the US dollar. The Bretton Woods

Agreement ultimately failed to peg gold to the US dollar because there wasn't sufficient gold

to support the amount of US dollars in circulation.

In 1971 the Bretton Woods Agreement was broken, and a modern foreign currency exchange

was born. This is where the history of the Forex market, as we know it, began.

In the 1970s and 1980s, forex transactions were limited to large banks and financial

institutions; non-banks only had access to the foreign exchange market through a banking

relationship. But in the 1990s, as the Internet spread worldwide, banks and small businesses

began networking online to prepare automated quotes and negotiate immediately.

Simultaneously, online trading platforms began to emerge, allowing people to trade in the

forex markets for the first time. Between 2000 and 2010, the forex market boomed as new

brokerage and electronic trading platforms expanded currency trading opportunities to an

increasing number of small participants.

4. Two to three prominent figures (individuals or organizations) from this area?

5. What were their major contributions that make them significant?

The IMF, International Monetary Fund, has survived the demise of the Bretton Woods

system. Today it lends money to developing countries or those in crisis or to communist

countries changing to capitalism. It can impose strict rules over the loan recipients'

economies to force them to repay their debt.

Another organization created by the Bretton Woods Agreement — the International Bank for

Reconstruction and Development (IBRD), or World Bank, has also survived. The World
Bank's original purpose was to finance the reconstruction of Europe and Asia after World

War II. Today, the World Bank loans money, mostly to developing countries, for commercial

and infrastructure projects, and the loans must be backed by the government receiving the

loans. It does not, however, compete with commercial banks.

6. In the context of India, what are the key positive and normative questions from the

field of foreign exchange

Positive Questions:-

How does RBI keep a check on the foreign exchange rate and foreign currency demand?

When and why does the official reserve transactions take place?

Normative Questions:-

What should the government do to decrease inflation and strengthen the Indian Rupee against

the US Dollar?