Introduction
Among the various financial markets around the globe, foreign exchange markets qualify as the largest and the most liquid. Also known as the currency market, it is widely distributed all over the world and deals with the trading of currencies. The system determines the worth or value of currencies used in the world. The main objective of this market is to aid in international businesses and investments by providing an easy means for the businesses to deal with all currencies through an easy conversion process from one currency to the other.
The market deals with very huge business volumes, which cause high liquidity operating for 24 hours five days a week. Illustrating the evident changes in the market, Bernard (2007) points out that, “From the early 1970s, the market has been greatly transformed in structure, operation and size” (p.56). Results from researches carried out about the market reveal how it continues to grow over years and by April 2010, it was estimated to have a US$3.98 trillion as its daily turnover, an increase of 20% from April 2007. This massive money movement comes from various institutions such as the governments, banks, among other financial markets. One can ask, ‘What is the fuel behind the increase in exchange markets?’
The increase of foreign exchange markets turnover has come because of factors like the increase in trading activities by high-frequency investors, the popularity of the foreign exchange as a means of acquiring assets, and the introduction of retail investors who have formed a very crucial market segment. Julian (2000) comes in handy claiming “…that the growth of the electronic methods of executing foreign exchange and availability of a diverse selection of the execution venues has resulted in lower transaction costs” (p.114). Moreover, the increased market liquidity, the evident rise in the number of enterprises and capitalists into the foreign exchange market has come as a result. In general, online electronic trading has made the execution of the foreign exchange market easy thus resulting in a lot of growth and high turnover.
Asharaf (2008) states, “Traditionally, the foreign exchange market was the realm of the big corporations and the major banks. But the advent of online trading avenues and the regulations in investment, the once rigid market has opened opportunities for smaller corporations, retail investors and small financial institutions to freely participate in this market” (p.115). However, these markets affect the economy of other countries.
Effects on the economy
“The foreign exchange markets describe the valuations of domestic currencies, which affect the political and economic status of the nations” (Bradley, 2007, p.66). During low foreign exchange rates in a country, it implies that the economic recession and the political stability are eminent or in existence in that particular country. On the other hand, strong and high exchange rates indicate that the country has a lot of political stability and a very strong economy. Hiroya (1994) exposits, “The foreign exchange market effect to the country’s economy as a whole is initially a macro experience and it then goes down to the basic unit of the country’s economy, the ordinary country consumer” (p.34). Thus, the foreign exchange market affects both the major and minor sectors of a country’s economy.
The foreign exchange markets influence the capital flows into and out of any country. Worth noting is that virtually all countries that experience a frequent currency values deterioration, repel many foreign investors. Bernard (2007) asserts, “Owing to their minimized purchasing powers, stocks, real estates as well as bonds tend to be liquidated by the aliens of these countries” (p.50). This turns out as the only possible take as one compares the aforementioned assets to other countries’ currency investments. International investors prefer purchasing or investing in countries, which depict very strong and increasing exchange rates.
The low exchange rates will improve tourism activities in a country since the domestic goods will be cheap as compared to foreign goods. Thus, many tourists will tend to visit this country owing to their high purchasing powers. Foreign markets have a good deal of implications ranging from political, through social to economic. When the exchange rates are unfavorable, citizens and investors feel discouraged to carry out economic activities in the country and there will be unrest, which may lead to violence. Business investors will tend to shun away from the country having unstable governments, as they are afraid to take their investments in those countries because they will be prone to many upheavals, affecting the country’s economy largely.
If a country has stable foreign exchange rates, its goods and services will increase in demand thus increasing trade activities in that country which in turn increases the income earnings which results in a lot of economic growth. The level of employment will increase when the value of a country’s currency increases in the foreign market, and as investors start new investments in the country, the new investments will demand human labor thus resulting in the employment of many people in the various sectors of the economy.
The resistance of the countries to the change
Many countries are reluctant to change with the change in foreign exchange markets. A fluctuating exchange rate also called a floating exchange rate is the one in which a country’s currency is permitted to fluctuate based on how the foreign exchange market changes. Many countries prefer fixed exchange rates because they offer greater certainty and stability. However, this may not necessarily be the case after considering the past results of countries. Countries like the UK and Southeast Asia “…that have attempted to maintain their currency prices “strong” and “high”… before the emergence of Asian Currency Crisis” (Bernard, 2007, p.54) depict a different trend.
Following the prevailing issue of currency fluctuations, Central banks enter the market to help restore the stability of currencies. This situation happens to incase of a tremendous decline or an increase in the currency of a particular country. The price ceiling and the price floor are the limits within which banks like Central banks allow free floating of their currencies. Bradley (2007) asserts, “Countries tend to resist the changes in foreign exchange markets because it increases the volatility of the countries to the foreign exchange and some economists argue that it can cause a lot of problems especially in the emerging economies” (p.74). In case of an unforeseen downfall in the exchange rates with the assets being designated in the local currency while the liabilities are in the foreign, there arises a great effect in banks and other financial institutions. The situation becomes so severe interfering with the financial stability of many countries.
Conclusion
Thus, emerging countries tend to resist the change because they have very small variations of their nominal rate of exchange. This has led to a lot of resistance by many countries and especially the ones with growing economies referred to as the developing countries.
Reference List
Asharaf, L. (2008). Currency Trading and Intermarket Analysis.Toronto: Wiley Publishers. Print.
Bernard, B. (2007). The Secrets of Economic Indicators. New Jersey: Pearson Prentice Hall. Print.
Bradley, R. (2007). The Macro Economy Today. New York: McGraw-Hill. Print.
Hiroya, A. (1994). Structural Changes in foreign Exchange Markets. Novato: Nataraj Publishers. Print.
Julian, W. (2000). The Foreign Exchange and Money Markets Guide. San Francisco: Wiley publishers. Print.