International Business - Foreign Exchange Markets Summary - Essay Example

Running head: The Gold Standard and Foreign Exchange Markets Gold has at all times held an allure and has been in use and is still being used for purposes such as jewelry, coinage, protection against political instability and inflation and as store of value. The most eminent monetary system that has ever existed is the gold standard. Nevertheless, its 1973 fall demanded the floating of the major currencies in the foreign exchange markets: a system known as ‘floating currency’ financial system. The foreign exchange market, which is the largest global financial market, caters for money transfer from one country to another, which nearly all international business undertakings call for. This paper explains the gold standard and as well gives the functions of the world’s major foreign exchange market along with a discussion of the negative and positive aspects of using the gold standard. Introduction We can define gold standard as the utilization of gold as a country’s currency standard value. Countries that redeem their money in gold are said to be using the gold standard. The gold standard was an allegiance by the United States together with several other Western countries during the early 1900s to fix their domestic currencies prices in terms of a definite gold amount. Freely and at the fixed price, these countries converted the national money plus other money forms, for example notes and bank deposits, into gold. Put differently, each country set a definite number of its currency’s units per ounce of gold. Between any two currencies, the exchange rate was the comparison of the numbers of units per ounce between countries. The gold standard was not only a domestic standard that regulated the money supply amount and growth rate of a country, but also an international standard that determined a country’s currency value in terms of other countries’ currencies (The McGraw-Hill Companies, 2005). From the time when the standard’s devotees endorsed a fixed price for gold, exchange rates between currencies tied to gold were fixed. Following the fixed exchange rates, the world’s price levels started to move together and this came about predominantly through an automatic balance of payments-adjustment process identified as the mechanism of price-specie-flow. It also enabled the transmission of both non-monetary and monetary shocks via capital and gold flows between countries. Consequently, the effects of a shock in one country stroke another country’s real expenditure, price level, income and domestic money supply. In the period flanked by 1880 and 1914, identified as the classical gold standard, most countries exhibited varying degrees of adherence to gold. Extraordinary economies’ growth with fairly free trade in labor, capital and goods were characteristic of this period (Bordo, 2008). For the functioning and extension of the gold standard, there were countries that were core and fundamental including Britain since 1801, the U.K. since 1992 and in the interwar period, the United States. Britain, in the classical standard, had ‘the United Kingdom of Great Britain and Ireland’ as its legal name since 1801 while the U.K. had ‘the United Kingdom of Great Britain and Northern Ireland’ as its legal name since 1922. They, along with other core countries, caught the attention of other countries mainly Scandinavia, Western European countries and British dominions and colonies into embracing/adopting the gold standard. During the First World War, Britain experienced financial burdens, which forced her to trade a considerable amount of her gold and this led to the end of the gold standard in Britain. In history, the world got into the first era in August 1971 whereby utterly nobody could redeem any paper that was in circulation in gold. A momentous event is when the then United States’ President – Richard Nixon closed the ‘gold window’ and declared gold ownership by United States’ citizens illegal. This move culminated into breaking of the last tie connecting gold with circulating currency in 1973, ensuing in the instigation of the floating of the major currencies in the foreign exchange markets – a system that is identified in the present world as the ‘floating currency’ financial system. Ever since, the government of the United States ceased to set a dollar’s gold value. Conversely, Western Europe retreated towards the European Monetary System, which is a fixed system. In effect, eleven European countries moved into the euro in the year 1999 (The McGraw-Hill Companies, 2005). Foreign Exchange Market, universally branded as FOREX, is a place where one can borrow, sell or buy monies. In addition to offering purchasing power from one currency to another, for instance the conversion of pounds or yen into dollars, FOREX provides countries with the resources for making payments as well as for funds transfer across borders – provisions that make currency valuations available for the establishment of the exchange rate, one of the greatest FOREX’s functions (SeaZone, 2008). Foreign Exchange Markets are in various nations and cities, with the prime and the largest one being London, which has 31% of activity. After London is New Yolk, then Tokyo, Singapore and so on with 16%, 9% and 6% of activity respectively. Other indispensable markets are in San Francisco, Paris, Hong Kong, Bahrain, Zurich, Frankfurt and Los Angeles. Trades at one or more of these markets can go on twenty-four hours a day. London’s dominance in FOREX is attributable to both its geography and history: compared with other markets, London market’s transaction opportunities are more in consequence of its tendency to shares its morning session-trading hours with markets in the Middle East plus Asia and its afternoon session-trading hours with the New York market (The McGraw-Hill Companies, 2005). Generally, firms engaged in foreign trade transactions, central banks, commercial banks, broker companies, investment funds, exchange markets and private persons constitute the chief FOREX’s participants. Principally, foreign exchange markets facilitate the conversion or buying and selling of disparate countries’ money or determine and accommodate a rate of exchange determined using the basic principles of supply and demand. They, in addition, diminish risks by shielding against the risks stemming from alterations in exchange rates. Nonetheless, the foreign exchange markets are devoid of the capacity to indemnify against FOREX trading tutorial risk fully. The McGraw-Hill Companies asserts that although foreign exchange markets were unwavering prior to the First World War, they experienced many transformations from the commencement of 1931 to 1973. After this war, they underwent a rapidly increase with speculative activity. The 1931 elimination of the gold standard and the largest counter attack resulted into a severe problem in FOREX’s activity. The gold standard has a number of merits, one of them being that it ascertained long-term stability of prices. It reduces international trade uncertainty via its provision of a fixed pattern of international exchange rates. It also discourages budget and trade deficits as well as government debt – countries wishing to pay their creditors had to lose gold from their reserves in case they had any debts. It as well gives direct rewards to nations that are more productive (evident in their exports). Another merit of the gold standard is that it stirs exploration, for instance it inspired the 1800s California and Alaska Gold Rush in pursuit of a boost to their prosperity. It also allows backing-up a country’s money with a fixed asset, thus providing the economy of the country with a stabilizing and self-regulating effect. Moreover, it denies a country’s government a chance to print more money than its country has in gold, which protects the country against inflation. This is in addition to discouraging budget deficits and government debt, as these cannot exceed gold supply (Amadeo, 2009). On the other hand, a gold standard has drawbacks, which includes making countries become infatuated with keeping hold of their gold, rather than improving the business climate. More so, government’s actions in attempt to protect their gold reserves, for instance raising interest rates, culminated to great economic fluctuations. In effect, the United States experienced five major recessions when on the gold standard. Worse still, since in a gold standard the gold supply determines a country’s amount of money, monetary policy therefore could not stabilize the times of economic recession. Additionally, since gold production rate determines monetary policy, deflation or inflation could occur following a reduction or an increase in mined gold respectively. Moreover, since the gold standard permits very little discretion for government to utilize monetary policy, nations using it encounter problems in avoiding or offsetting either real or monetary shocks, not mentioning the resource cost of gold production, which is exceptionally high (Amadeo, 2009). Conclusion The current globalization of capital and financial transactions has significantly transformed the foreign exchange market. Its trading volumes are expanding quickly owing to the automation of trading functions, opening of the market access to a broader range of participants and changing technology. Arguably, the foreign exchange market is becoming operationally efficient as well as increasingly liquid. Concerning gold, although its role in the present world-monetary system is negligible, its holdings are still maintained since it has received international recognition and interested countries cannot manipulate or legislate upon it. Gold is a beautiful and a precious metal that is still impressive and intriguing on people and still adorns kings’ relics as well as having numerous state-of-the-art uses. References Amadeo, K. (2009): How Would a Return to the Gold Standard Affect the U.S. Economy? Retrieved February 10, 2010, from http://useconomy.about.com/bio/kimberly-Amadeo-22286.htm Bordo, M.D., (2008): Gold Standard. Retrieved February 9, 2010, from http://www.econlib.org/library/Enc/GoldStandard.html SeaZone, (2008): Functions of Foreign Exchange Markets and the Gold Standard. Retrieved February 10, 2010, from http://www.associatedcontent.com/user/122896/seazone.html The McGraw-Hill Companies, (2005): Understanding the International Monetary System. Retrieved February 9, 2010, from http://www.google.co.ke/search?hl=en&source=hp&q=Understanding+the+International+Monetary+System+byThe+McGraw-Hill+Companies+2005&meta=&aq=f&oq= Read More