The Foreign Exchange Market

At one time, international currency was comparable because it was gold and silver; however, in our current society, countries’ currencies differ, so the foreign exchange market provides a means to understand various rates. Fundamentally, it is the largest liquid market in the world. In order to benefit their economies, governments intervene in the foreign exchange market by using direct and indirect methods.

Monetary authorities intervene in order to stabilize exchange rates. Intervention is a global practice, so direct intervention purchases or sells other currency in hopes that it will appreciate. Indirect intervention relies on changing interest rates. When countries support foreign currency, its demands will rise. Because they hope to maintain healthy economies, countries will often buy and trade with one another. 

Simwaka and Leslie (2012) noted that Malawi’s managed float exchange rate was adopted to resolve the crisis from their 90s drought. In that time, “the Malawi kwacha/US dollar exchange rate depreciated from around K4.5 in February to over K17 in September 1994” (pg. 126). Usually, governments may interfere due to a country losing commodities from a natural disaster. Similarly, The Economist (2013) reported that after Haiti’s earthquake and the 2012 tropical storms, their currency depreciated.

In order to offset intervention, a central bank may execute a sterilized intervention. In Malawi’s case, Simwaka and Leslie (2012) explained that a “Sterilized intervention can affect the exchange rate” (pg. 429). In other words, using a sterilized intervention may increase or decrease the supply of debt. The Reserve Bank of Malawi sold with the intention of the kwacha appreciating; however, it depreciated instead (Simwaka and Leslie, 2012). Thereupon lays the danger of hoping that currency will appreciate in harsh economic climates, so in order for Malawi’s currency to become a valuable commodity, it will have to depend on its resources to procure it. 

In American finance, Weithers (2006) noticed that the US central bank has “severely diminished instances of their direct intervention” (pg. 79). One can date the United States’ records of intervention in 1998 and 2000.  Weithers (2006) pointed out that the European central bank intervened for the first time in 2000. In direct intervention, a central bank attempts to influence the exchange rate by discharging a hefty quota of it into an open market. On the other hand, indirect intervention affects the exchange rate by tactics such as lowering the bank reserve’s requirements or restricting currency trades.  

Global Insight (2013) predicted that the US dollar will “strengthen against the euro in 2013 as the Eurozone recession drags on” (pg. 11).  Zeiler (2013) revealed that regardless of the US central bank’s attempt to “debase” our dollar, it still remains the world’s most popular currency. Zeiler (2013) speculated that our dollar’s popularity is due to the relatively decent shape of our economy. At the same time, globalization has enhanced our international market, so it ultimately depends on what each country can supply to the next. 

Countries rely on their economies to flourish, so the foreign exchange market allows us to trade and deal legitimately. Depending on our economy’s health, monetary authorities establish if their intervention should be indirect or direct. Ultimately, an effective intervention is a planned and well-executed leap of faith.

References

The Americas. (2013, January 5). Still waiting for recovery. The Economist. Retrieved from http://www.economist.com/news/americas/21569026-three-years-after-devastating-earthquake-republic-ngos-has-become-country

Global Insight. (2013). Country intelligence report (Vol. February, pp. 1-24) (United States, IHS).

K., & Mkandawire, L. (2012). The Efficacy of Official Intervention in the Foreign Exchange Market in Malawi. African Development Review, 24(2), 125-136.

Weithers, T. M. (2006). Brief history of the foreign exchange. In Foreign exchange: A practical guide to the FX markets (pp. 63-80). Hoboken, NJ: John Wiley & Sons.

Zeiler, D. (2013, July 2). Why the U.S. Dollar is Rising – And Why It's Still Doomed - Money Morning. Money Morning Only the News You Can Profit From. Retrieved from http://moneymorning.com/2013/07/02/why-the-u-s-dollar-is-rising-and-why-its-still-doomed/