Welcome to a four part series covering the highs and lows of the foreign exchange market, specifically focusing on the U.S. Dollar and the Euro. This series of articles is designed to give you an insight into what factors have been causing such drastic price swings in the exchange rate between the world’s two most important currencies. This first article will try and define the relationship of the Dollar and Euro, and how commodities as well as inflation have played a central role in the forex markets over the last two years.
I want to begin by offering a brief overview of the foreign market and its importance in the global economy. The forex exchange market is one of the largest and most liquid securities exchanges in the world with over $3.2 trillion in average daily turnover. This equates to 10 times the average daily turnover of global equity markets and 35 times the average daily turnover of the New York Stock Exchange. The forex market is open 24 hours a day, 6 days a week, with the EUR/USD accounting for 27% of total turnover. There is plenty of opportunity to make and lose money in currency exchange, as is evidence over the last 3-4 years as the Euro has risen to all-time versus the Dollar and more recently has faced intense selling pressure with the steep decline in oil prices and the global economic recession.
The Gold Standard No More
The gold standard era in the U.S. officially began with the passing of the Gold Standard Act in 1900. But it was not until World War II that brought about the need for a worldwide standard for currency values and exchange rates. The Bretton Woods Agreement in 1944 established two very important international institutions: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (now the World Bank). What came from this agreement was that all the world’s currencies would be pegged against the value of gold, and with the U.S. dollar on the gold standard, the U.S. dollar effectively became the world’s reserve currency. The value of gold was fixed at $35 per ounce until the gold standard was effectively withdrawn in 1971 as President Nixon ordered an end to the out-dated system and the price of gold was allowed to “float”. Now, every major currency is no longer on the gold standard but rather is referred to as “fiat” currency. This basically means that a country’s own currency is intrinsically worthless because it is not backed by any type of reserve, such as gold. The value each currency is therefore based citizen’s perception of their economy, supply and demand for money in general, and how their currency is compared to other country’s currency.
Something to think about though is 40 years ago, the world’s currencies used to be pegged against the price of gold and ultimately the Dollar. Now it would not be a stretch to say that global currency is on an Oil Standard. When the U.S.
