### FOREX TRADING

Saturday, August 29, 2009

Foreign exchange market (Redirected from Forex)Jump to: navigation, search This article needs additional citations for verification.Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (July 2008)Foreign exchangeExchange ratesCurrency bandExchange rateExchange rate regimeFixed exchange rateFloating exchange rateLinked exchange rateMarketsForeign exchange marketFutures exchangeRetail forexProductsCurrencyCurrency futureNon-deliverable forwardForex swapCurrency swapForeign exchange optionSee alsoBureau de changeThe foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is the largest and most liquid financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex and related markets is continously growing and was last reported to be over US$4 trillion in April 2007 by the Bank for International Settlement.[1]Contents[hide]* 1 Market size and liquidity * 2 Market participants o 2.1 Banks o 2.2 Commercial companies o 2.3 Central banks o 2.4 Hedge funds o 2.5 Investment management firms o 2.6 Retail forex brokers o 2.7 Other * 3 Trading characteristics * 4 Factors affecting currency trading o 4.1 Economic factors o 4.2 Political conditions o 4.3 Market psychology * 5 Algorithmic trading in forex * 6 Financial instruments o 6.1 Spot o 6.2 Forward o 6.3 Future o 6.4 Swap o 6.5 Option o 6.6 Exchange Traded Fund * 7 Speculation * 8 References * 9 See also * 10 External links Market size and liquidityThe foreign exchange market is unique because of* its trading volumes, * the extreme liquidity of the market, * the large number of, and variety of, traders in the market, * its geographical dispersion, * its long trading hours: 24 hours a day except on weekends (from 3pm EST on Sunday until 4pm EST Friday), * the variety of factors that affect exchange rates. * the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes) * the use of leverageMain foreign exchange market turnover, 1988 - 2007, measured in billions of USD.Main foreign exchange market turnover, 1988 - 2007, measured in billions of USD.As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks. According to the BIS,[1] average daily turnover in global foreign exchange markets is estimated at$3.98 trillion. Trading in the world's main financial markets accounted for $3.21 trillion of this.This$3.21 trillion in main foreign exchange market turnover was broken down as follows:* $1.005 trillion in spot transactions *$362 billion in outright forwards * $1.714 trillion in forex swaps *$129 billion estimated gaps in reportingOf the $3.98 trillion daily global turnover, trading in London accounted for around$1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.In addition to "traditional" turnover, 2.1 trillion was traded in derivatives.Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).Top 10 currency traders [2]% of overall volume, May 2008 Rank Name Volume1 Flag of Germany Deutsche Bank 21.70%2 Flag of Switzerland UBS AG 15.80%3 Flag of the United Kingdom Barclays Capital 9.12%4 Flag of the United States Citi 7.49%5 Flag of the United Kingdom Royal Bank of Scotland 7.30%6 Flag of the United States JPMorgan 4.19%7 Flag of the United Kingdom HSBC 4.10%8 Flag of the United States Lehman Brothers 3.58%9 Flag of the United States Goldman Sachs 3.47%10 Flag of the United States Morgan Stanley 2.86%Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as internet trading platforms offered by companies such as First Prudential Markets and Saxo Bank have made it easier for retail traders to trade in the foreign exchange market. [3]Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 34.1% in April 2007. RPPThe ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 on a retail broker. Minimum trading size for most deals is usually 100,000 units of currency, which is a standard "lot".These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e. 0.0003). Competition is greatly increased with larger transactions, and pip spreads shrink on the major pairs to as little as 1 to 2 pips. Market participantsFinancial marketsBond marketFixed incomeCorporate bondGovernment bondMunicipal bondBond valuationHigh-yield debtStock marketStockPreferred stockCommon stockRegistered shareVoting shareStock exchangeForeign exchange marketDerivatives marketCredit derivativeHybrid securityOptionsFuturesForwardsSwapsOther MarketsCommodity marketMoney marketOTC marketReal estate marketSpot marketFinance seriesFinancial marketFinancial market participantsCorporate financePersonal financePublic financeBanks and BankingFinancial regulation v • d • eUnlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs. BanksThe interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account.Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago. Commercial companiesAn important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants. Central banksNational central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high — that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.[4] Several scenarios of this nature were seen in the 1992–93 ERM collapse, and in more recent times in Southeast Asia. Hedge fundsHedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor. Investment management firmsInvestment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the number of this type of specialist firms is quite small, many have a large value of assets under management (AUM), and hence can generate large trades. Retail forex brokersThere are two types of retail brokers offering the opportunity for speculative trading. Retail forex brokers or Market makers. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail forex brokers, while largely controlled and regulated by the CFTC and NFA might be subject to forex scams[5] [6]. At present, the NFA and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. As a result many of the smaller, and perhaps questionable brokers are now gone. It is not widely understood that retail brokers and market makers typically trade against their clients and frequently take the other side of their trades. This can often create a potential conflict of interest and give rise to some of the unpleasant experiences some traders have had. A move toward NDD (No Dealing Desk) and STP (Straight Through Processing) has helped to resolve some of these concerns and restore trader confidence, but caution is still advised in ensuring that all is as it is presented. OtherNon-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as Foreign Exchange Brokers but are distinct from Forex Brokers as they do not offer speculative trading but currency exchange with payments. i.e. there is usually a physical delivery of currency to a bank account.It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies[7]. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.Money Transfer/Remittance Companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally. Trading characteristicsMost traded currencies[1]Currency distribution of reported FX market turnover Rank Currency ISO 4217 code(Symbol) % daily share(April 2007)1 Flag of the United States?United States dollar USD ($) 86.3%2 Flag of Europe?Euro EUR (€) 37.0%3 Flag of Japan?Japanese yen JPY (¥) 16.5%4 Flag of the United Kingdom?Pound sterling GBP (£) 15.0%5 Flag of Switzerland?Swiss franc CHF (Fr) 6.8%6 Flag of Australia?Australian dollar AUD ($) 6.7%7 Flag of Canada?Canadian dollar CAD ($) 4.2%8-9 Flag of Sweden?Swedish krona SEK (kr) 2.8%8-9 Flag of Hong Kong?Hong Kong dollar HKD ($) 2.8%10 Flag of Norway?Norwegian krone NOK (kr) 2.2%11 Flag of New Zealand?New Zealand dollar NZD ($) 1.9%12 Flag of Mexico?Mexican Peso MEX ($) 1.3%Other 16.8%Total 200%There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. A joint venture of the Chicago Mercantile Exchange and Reuters, called FxMarketSpace opened in 2007 and aspires to the role of a central market clearing mechanism.The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.There is little or no 'inside information' in the foreign exchange markets. Exchange rate fluctuations are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX is expressed (called base currency). For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.5465 dollar. Out of convention, the first currency in the pair, the base currency, was the stronger currency at the creation of the pair. The second currency, counter currency, was the weaker currency at the creation of the pair.The factors affecting XXX will affect both XXX/YYY and XXX/ZZZ. This causes positive currency correlation between XXX/YYY and XXX/ZZZ.On the spot market, according to the BIS study, the most heavily traded products were:* EUR/USD: 27 % * USD/JPY: 13 % * GBP/USD (also called sterling or cable): 12 %and the US currency was involved in 86.3% of transactions, followed by the euro (37.0%), the yen (16.5%), and sterling (15.0%) (see table). Note that volume percentages should add up to 200%: 100% for all the sellers and 100% for all the buyers.Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EUR/USD and USD/ZZZ. The exception to this is EUR/JPY, which is an established traded currency pair in the interbank spot market. As the dollar's value has eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has increased dramatically. Transactions in the currencies of commodity-producing countries, such as AUD, NZD, CAD, have also increased. Factors affecting currency tradingSee also: Exchange ratesAlthough exchange rates are affected by many factors, in the end, currency prices are a result of supply and demand forces. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology. Economic factorsThese include economic policy, disseminated by government agencies and central banks, economic conditions, generally revealed through economic reports, and other economic indicators.Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).Economic conditions include:Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.Inflation levels and trends: Typically, a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.Economic growth and health: Reports such as gross domestic product (GDP), employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Political conditionsInternal, regional, and international political conditions and events can have a profound effect on currency markets.For instance, political upheaval and instability can have a negative impact on a nation's economy. The rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive or negative interest in a neighboring country and, in the process, affect its currency. Market psychologyMarket psychology and trader perceptions influence the foreign exchange market in a variety of ways:Flights to quality: Unsettling international events can lead to a "flight to quality," with investors seeking a "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The Swiss franc has been a traditional safe haven during times of political or economic uncertainty.[8]Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends. [9]"Buy the rumor, sell the fact:" This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".[10] To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns. [11] Algorithmic trading in forexElectronic trading is growing in the FX market, and algorithmic trading is becoming much more common. According to financial consultancy Celent estimates, by 2008 up to 25% of all trades by volume will be executed using algorithm, up from about 18% in 2005.[citation needed] Financial instruments SpotA spot transaction is a two-day delivery transaction (except in the case of the Canadian dollar, which settles the next day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot has the largest share by volume in FX transactions among all instruments. ForwardSee also: forward contractOne way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years. FutureMain article: Currency futureForeign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. SwapMain article: Forex swapThe most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. OptionMain article: Foreign exchange optionA foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world. Exchange Traded FundMain article: Exchange-traded fundExchange-traded funds (or ETFs) are Open Ended investment companies that can be traded at any time throughout the course of the day. Typically, ETFs try to replicate a stock market index such as the S&P 500 (e.g. SPY), but recently they are now replicating investments in the currency markets with the ETF increasing in value when the US Dollar weakens versus a specific currency, such as the Euro. Certain of these funds track the price movements of world currencies versus the US Dollar, and increase in value directly counter to the US Dollar, allowing for speculation in the US Dollar for US and US Dollar denominated investors and speculators. SpeculationControversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, economists including Milton Friedman have argued that speculators ultimately are a stabilizing influence on the market and perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do.[12] Other economists such as Joseph Stiglitz consider this argument to be based more on politics and a free market philosophy than on economics.[13]Large hedge funds and other well capitalized "position traders" are the main professional speculators.Currency speculation is considered a highly suspect activity in many countries. While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to this view, it is simply gambling that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 500% per annum, and later to devalue the krona[14]. Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view. He blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators.[15]Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit.[15]In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and forex speculators allegedly made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions. Given that Malaysia recovered quickly after imposing currency controls directly against IMF advice, this view is open to doubt. READ MORE - FOREX TRADING ### RETAIL FOREX Retail forexFrom Wikipedia, the free encyclopediaJump to: navigation, search This article or section is missing citations or needs footnotes.Using inline citations helps guard against copyright violations and factual inaccuracies. (May 2007)Foreign exchangeExchange ratesCurrency bandExchange rateExchange rate regimeFixed exchange rateFloating exchange rateLinked exchange rateMarketsForeign exchange marketFutures exchangeRetail forexProductsCurrencyCurrency futureNon-deliverable forwardForex swapCurrency swapForeign exchange optionSee alsoBureau de changeIn financial markets, the retail forex (retail currency trading or retail FX) market is a subset of the larger foreign exchange market. This "market has long been plagued by swindlers preying on the gullible," according to The New York Times[1]. It's commonly thought that about 90% of all retail FX traders lose money. [2] [3]Contents[hide]* 1 History * 2 Key Concepts Behind a Retail Forex Trade o 2.1 Currency Pairs o 2.2 High Leverage o 2.3 Transaction Costs and Market Makers o 2.4 Financial Instruments * 3 References * 4 See also HistoryTop 6 Most Traded Currencies Rank Currency ISO 4217Code Symbol1 Flag of the United States United States dollar USD$2 Flag of Europe  euro EUR €3 Flag of Japan Japanese yen JPY ¥4 Flag of the United Kingdom British pound sterling GBP £5/6 Flag of Switzerland Swiss franc CHF -Flag of Australia Australian dollar AUD $While forex has been traded since the beginning of financial markets, on-line retail trading has only been active since about 1996 . From the 1970s, larger retail traders could trade FX contracts at the Chicago Mercantile Exchange.[1]By 1996 on-line retail forex trading became practical. Internet-based market makers would take the opposite side of retail trader’s trades. These companies also created online trading platforms that provided a quick way for individuals to buy and sell on the forex spot market.In online currency exchange, few or no transactions actually lead to physical delivery to the client; all positions will eventually be closed. The market makers offer high amounts of leverage. While up to 4:1 leverage is available in equities and 20:1 in Futures, it is common to have 100:1 leverage in currencies.]].[1] In the typical 100:1 scenario, the client absorbs all risks associated with controlling a position worth 100 times his capital.Currencies are quoted in pairs, for example EUR/USD (euro versus United States dollar). The first currency is the base currency and the second currency is the quote currency. A person who is short the EUR/USD will have a loss if the USD loses value and make a profit if the EUR loses value. A person who is long the EUR/USD will make a profit if the USD loses value and have a loss if the EUR loses value. Key Concepts Behind a Retail Forex Trade Currency PairsCurrency prices can only fluctuate relative to another currency, so they are traded in pairs. Take two of the most common currency pairs, the EUR/USD (the price for euros in US dollars) and the GBP/USD (the price for the British pound in US dollars). High LeverageThe idea of margin (leverage) and floating loss is another important trading concept and is perhaps best understood using an example. Most retail Forex market makers permit 100:1 leverage, but also, crucially, require you to have a certain amount of money in your account to protect against a critical loss point. For example, if a$100,000 position is held in EUR/USD on 100:1 leverage, the trader has to put up $1,000 to control the position. However, in the event of a declining value of your positions, Forex market makers, mindful of the fast nature of forex price swings and the amplifying effect of leverage, typically do not allow their traders to go negative and make up the difference at a later date. In order to make sure the trader does not lose more money than is held in the account, forex market makers typically employ automatic systems to close out positions when clients run out of margin (the amount of money in their account not tied to a position). If the trader has$2,000 in his account, and he is buying a $100,000 lot of EUR/USD, he has$1,000 of his $2,000 tied up in margin, with$1,000 left to allow his position to fluctuate downward without being closed out.Typically a trader's trading platform will show him three important numbers associated with his account: his balance, his equity, and his margin remaining. If trader X has two positions: $100,000 long (buy) in EUR/USD, and$100,000 short (sell) in GBP/USD, and he has $10,000 in his account, his positions would look as follows: Because of the 100:1 leverage, it took him$1,000 to control each position. This means that he has used up $2,000 in his margin, out of a$10,000 account, and thus he has $8,000 of margin still available. With this margin, he can either take more positions or keep the margin relatively high to allow his current positions to be maintained in the event of downturns. If the client chooses to open a new position of$100,000, this will again take another $1,000 of his margin, leaving$7,000. He will have used up $3,000 in margin among the three positions. The other way margin will decrease is if the positions he currently has open lose money. If his 3 positions of$100,000 decrease by $5,000 in value (which is fairly common), he now has, of his original$7,000 in margin, only $2,000 left.If you have a$10,000 account and only open one $100,000 position, this has committed only$1,000 of your money plus you must maintain $1,000 in margin. While this leaves$9,000 free in your account, it is possible to lose almost all of it if the speculation loses money. Transaction Costs and Market MakersMarket makers are compensated for allowing clients to enter the market. They take part or all of the spread in all currency pairs traded. In a common example, EUR/USD, the spread is typically 3 pips (3/100 of a cent). Thus prices are quoted with both bid and offer prices (e.g., Buy EUR/USD 1.4900, Sell EUR/USD 1.4903).That difference of 3 pips is the spread and can amount to a significant amount of money. Because the typical standard lot is 100,000 units of the base currency, those 3 pips on EUR/USD translate to $30 paid by the client to the market maker. However, a pip is not always$10. A pip is 1/100th of a cent (or whatever), and the currency pairs are always purchased by buying 100,000 of the base currency.For the pair EUR/USD, the quote currency is USD; thus, 1/100th of a cent on a pair with USD as the quote currency will always have a pip of $10. If, on the other hand, your currency pair has Swiss francs (CHF) as a quote instead of USD, then 1/100th of a cent is now worth around$9, because you are buying 100,000 of whatever in Swiss francs. Financial InstrumentsThere are several types of financial instruments commonly used.Forwards One way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.Futures Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.Swaps The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not contracts and are not traded through an exchange.Spot A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the Spot market.
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Foreign exchange marketFrom Wikipedia, the free encyclopedia (Redirected from Forex)Jump to: navigation, search This article needs additional citations for verification.Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (July 2008)Foreign exchangeExchange ratesCurrency bandExchange rateExchange rate regimeFixed exchange rateFloating exchange rateLinked exchange rateMarketsForeign exchange marketFutures exchangeRetail forexProductsCurrencyCurrency futureNon-deliverable forwardForex swapCurrency swapForeign exchange optionSee alsoBureau de changeThe foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is the largest and most liquid financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex and related markets is continously growing and was last reported to be over US$4 trillion in April 2007 by the Bank for International Settlement.[1]Contents[hide]* 1 Market size and liquidity * 2 Market participants o 2.1 Banks o 2.2 Commercial companies o 2.3 Central banks o 2.4 Hedge funds o 2.5 Investment management firms o 2.6 Retail forex brokers o 2.7 Other * 3 Trading characteristics * 4 Factors affecting currency trading o 4.1 Economic factors o 4.2 Political conditions o 4.3 Market psychology * 5 Algorithmic trading in forex * 6 Financial instruments o 6.1 Spot o 6.2 Forward o 6.3 Future o 6.4 Swap o 6.5 Option o 6.6 Exchange Traded Fund * 7 Speculation * 8 References * 9 See also * 10 External links Market size and liquidityThe foreign exchange market is unique because of* its trading volumes, * the extreme liquidity of the market, * the large number of, and variety of, traders in the market, * its geographical dispersion, * its long trading hours: 24 hours a day except on weekends (from 3pm EST on Sunday until 4pm EST Friday), * the variety of factors that affect exchange rates. * the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes) * the use of leverageMain foreign exchange market turnover, 1988 - 2007, measured in billions of USD.Main foreign exchange market turnover, 1988 - 2007, measured in billions of USD.As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks. According to the BIS,[1] average daily turnover in global foreign exchange markets is estimated at$3.98 trillion. Trading in the world's main financial markets accounted for $3.21 trillion of this.This$3.21 trillion in main foreign exchange market turnover was broken down as follows:* $1.005 trillion in spot transactions *$362 billion in outright forwards * $1.714 trillion in forex swaps *$129 billion estimated gaps in reportingOf the $3.98 trillion daily global turnover, trading in London accounted for around$1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.In addition to "traditional" turnover, 2.1 trillion was traded in derivatives.Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).Top 10 currency traders [2]% of overall volume, May 2008 Rank Name Volume1 Flag of Germany Deutsche Bank 21.70%2 Flag of Switzerland UBS AG 15.80%3 Flag of the United Kingdom Barclays Capital 9.12%4 Flag of the United States Citi 7.49%5 Flag of the United Kingdom Royal Bank of Scotland 7.30%6 Flag of the United States JPMorgan 4.19%7 Flag of the United Kingdom HSBC 4.10%8 Flag of the United States Lehman Brothers 3.58%9 Flag of the United States Goldman Sachs 3.47%10 Flag of the United States Morgan Stanley 2.86%Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as internet trading platforms offered by companies such as First Prudential Markets and Saxo Bank have made it easier for retail traders to trade in the foreign exchange market. [3]Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 34.1% in April 2007. RPPThe ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 on a retail broker. Minimum trading size for most deals is usually 100,000 units of currency, which is a standard "lot".These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e. 0.0003). Competition is greatly increased with larger transactions, and pip spreads shrink on the major pairs to as little as 1 to 2 pips. Market participantsFinancial marketsBond marketFixed incomeCorporate bondGovernment bondMunicipal bondBond valuationHigh-yield debtStock marketStockPreferred stockCommon stockRegistered shareVoting shareStock exchangeForeign exchange marketDerivatives marketCredit derivativeHybrid securityOptionsFuturesForwardsSwapsOther MarketsCommodity marketMoney marketOTC marketReal estate marketSpot marketFinance seriesFinancial marketFinancial market participantsCorporate financePersonal financePublic financeBanks and BankingFinancial regulation v • d • eUnlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs. BanksThe interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account.Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago. Commercial companiesAn important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants. Central banksNational central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high — that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.[4] Several scenarios of this nature were seen in the 1992–93 ERM collapse, and in more recent times in Southeast Asia. Hedge fundsHedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor. Investment management firmsInvestment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the number of this type of specialist firms is quite small, many have a large value of assets under management (AUM), and hence can generate large trades. Retail forex brokersThere are two types of retail brokers offering the opportunity for speculative trading. Retail forex brokers or Market makers. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail forex brokers, while largely controlled and regulated by the CFTC and NFA might be subject to forex scams[5] [6]. At present, the NFA and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. As a result many of the smaller, and perhaps questionable brokers are now gone. It is not widely understood that retail brokers and market makers typically trade against their clients and frequently take the other side of their trades. This can often create a potential conflict of interest and give rise to some of the unpleasant experiences some traders have had. A move toward NDD (No Dealing Desk) and STP (Straight Through Processing) has helped to resolve some of these concerns and restore trader confidence, but caution is still advised in ensuring that all is as it is presented. OtherNon-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as Foreign Exchange Brokers but are distinct from Forex Brokers as they do not offer speculative trading but currency exchange with payments. i.e. there is usually a physical delivery of currency to a bank account.It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies[7]. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.Money Transfer/Remittance Companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally. Trading characteristicsMost traded currencies[1]Currency distribution of reported FX market turnover Rank Currency ISO 4217 code(Symbol) % daily share(April 2007)1 Flag of the United States United States dollar USD ($) 86.3%2 Flag of Europe Euro EUR (€) 37.0%3 Flag of Japan Japanese yen JPY (¥) 16.5%4 Flag of the United Kingdom Pound sterling GBP (£) 15.0%5 Flag of Switzerland Swiss franc CHF (Fr) 6.8%6 Flag of Australia Australian dollar AUD ($) 6.7%7 Flag of Canada Canadian dollar CAD ($) 4.2%8-9 Flag of Sweden Swedish krona SEK (kr) 2.8%8-9 Flag of Hong Kong Hong Kong dollar HKD ($) 2.8%10 Flag of Norway Norwegian krone NOK (kr) 2.2%11 Flag of New Zealand New Zealand dollar NZD ($) 1.9%12 Flag of Mexico Mexican Peso MEX ($) 1.3%Other 16.8%Total 200%There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. A joint venture of the Chicago Mercantile Exchange and Reuters, called FxMarketSpace opened in 2007 and aspires to the role of a central market clearing mechanism.The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.There is little or no 'inside information' in the foreign exchange markets. Exchange rate fluctuations are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in GDP growth, inflation, interest rates, budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX is expressed (called base currency). For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.5465 dollar. Out of convention, the first currency in the pair, the base currency, was the stronger currency at the creation of the pair. The second currency, counter currency, was the weaker currency at the creation of the pair.The factors affecting XXX will affect both XXX/YYY and XXX/ZZZ. This causes positive currency correlation between XXX/YYY and XXX/ZZZ.On the spot market, according to the BIS study, the most heavily traded products were:* EUR/USD: 27 % * USD/JPY: 13 % * GBP/USD (also called sterling or cable): 12 %and the US currency was involved in 86.3% of transactions, followed by the euro (37.0%), the yen (16.5%), and sterling (15.0%) (see table). Note that volume percentages should add up to 200%: 100% for all the sellers and 100% for all the buyers.Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EUR/USD and USD/ZZZ. The exception to this is EUR/JPY, which is an established traded currency pair in the interbank spot market. As the dollar's value has eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has increased dramatically. Transactions in the currencies of commodity-producing countries, such as AUD, NZD, CAD, have also increased. Factors affecting currency tradingSee also: Exchange ratesAlthough exchange rates are affected by many factors, in the end, currency prices are a result of supply and demand forces. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology. Economic factorsThese include economic policy, disseminated by government agencies and central banks, economic conditions, generally revealed through economic reports, and other economic indicators.Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).Economic conditions include:Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.Inflation levels and trends: Typically, a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.Economic growth and health: Reports such as gross domestic product (GDP), employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Political conditionsInternal, regional, and international political conditions and events can have a profound effect on currency markets.For instance, political upheaval and instability can have a negative impact on a nation's economy. The rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive or negative interest in a neighboring country and, in the process, affect its currency. Market psychologyMarket psychology and trader perceptions influence the foreign exchange market in a variety of ways:Flights to quality: Unsettling international events can lead to a "flight to quality," with investors seeking a "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The Swiss franc has been a traditional safe haven during times of political or economic uncertainty.[8]Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends. [9]"Buy the rumor, sell the fact:" This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".[10] To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns. [11] Algorithmic trading in forexElectronic trading is growing in the FX market, and algorithmic trading is becoming much more common. According to financial consultancy Celent estimates, by 2008 up to 25% of all trades by volume will be executed using algorithm, up from about 18% in 2005.[citation needed] Financial instruments SpotA spot transaction is a two-day delivery transaction (except in the case of the Canadian dollar, which settles the next day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot has the largest share by volume in FX transactions among all instruments. ForwardSee also: forward contractOne way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years. FutureMain article: Currency futureForeign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. SwapMain article: Forex swapThe most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. OptionMain article: Foreign exchange optionA foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world. Exchange Traded FundMain article: Exchange-traded fundExchange-traded funds (or ETFs) are Open Ended investment companies that can be traded at any time throughout the course of the day. Typically, ETFs try to replicate a stock market index such as the S&P 500 (e.g. SPY), but recently they are now replicating investments in the currency markets with the ETF increasing in value when the US Dollar weakens versus a specific currency, such as the Euro. Certain of these funds track the price movements of world currencies versus the US Dollar, and increase in value directly counter to the US Dollar, allowing for speculation in the US Dollar for US and US Dollar denominated investors and speculators. SpeculationControversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, economists including Milton Friedman have argued that speculators ultimately are a stabilizing influence on the market and perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do.[12] Other economists such as Joseph Stiglitz consider this argument to be based more on politics and a free market philosophy than on economics.[13]Large hedge funds and other well capitalized "position traders" are the main professional speculators.Currency speculation is considered a highly suspect activity in many countries. While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to this view, it is simply gambling that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 500% per annum, and later to devalue the krona[14]. Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view. He blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators.[15]Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit.[15]In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and forex speculators allegedly made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions. Given that Malaysia recovered quickly after imposing currency controls directly against IMF advice, this view is open to doubt READ MORE - FOREX MARKET ### FOREX SWAP Forex swapFrom Wikipedia, the free encyclopediaJump to: navigation, searchForeign exchangeExchange ratesCurrency bandExchange rateExchange rate regimeFixed exchange rateFloating exchange rateLinked exchange rateMarketsForeign exchange marketFutures exchangeRetail forexProductsCurrencyCurrency futureNon-deliverable forwardForex swapCurrency swapForeign exchange optionSee alsoBureau de changeIn finance, a forex swap (or FX swap) is an over-the-counter short term interest rate derivative instrument. In emerging money markets, forex swaps are usually the first derivative instrument to be traded, ahead of forward rate agreements and before exotics.Contents[hide]* 1 Structure * 2 Uses o 2.1 Funding o 2.2 Hedging o 2.3 Speculation * 3 Pricing * 4 Related instruments * 5 See also StructureA forex swap consists of two legs:* a spot foreign exchange transaction, and * a forward foreign exchange transaction.These two legs are executed simultaneously for the same quantity, and therefore offset each other.It is also common to trade forward-forward, where both transactions are for (different) forward dates. UsesForex swaps are used for hedging currency positions and for speculation, but by far and away their most common use is for institutions to fund their foreign exchange balances. FundingOnce a foreign exchange transaction settles, the holder is left with a positive (or long) position in one currency, and a negative (or short) position in another. In order to collect or pay any overnight interest due on these foreign balances, at the end of every day institutions will close out any foreign balances and re-institute them for the following day. To do this they typically use tom-next swaps, buying (selling) a foreign amount settling tomorrow, and selling (buying) it back settling the day after.The interest collected or paid every night is referred to as the cost of carry. As currency traders know roughly how much holding a currency position will make or cost on a daily basis, specific trades are put on based on this; these are referred to as carry trades. HedgingInvestors use forex swaps to hedge their existing forex exposures by swapping temporary surplus funds in one currency into another currency for better use of liquidity. Doing so protects against adverse movements in the forex rate, but favourable moves are renounced. SpeculationInvestors use forex swaps to speculate on changes in the interest rate differentials between two currencies. PricingThe relationship between spot and forward is as follows:F = S \left( \frac{1+r_T T}{1+r_B T}\right)where:* F = forward * S = spot * rT = simple interest rate of the term currency * rB = simple interest rate of the base currency * T = tenor (calculated according to the appropriate day count convention)The forward points or swap points are quoted as the difference between forward and spot, F - S, and is expressed as the following:F - S = S \left( \frac{1+r_T T}{1+r_B T} -1 \right) \approx S \left( r_T - r_B \right) Twhere rT and rB are small. Thus, the absolute value of the swap points increases when the interest rate differential gets larger, and vice versa. Related instrumentsA forex swap should not be confused with a currency swap, which is a much rarer, long term transaction, governed by a slightly different set of rules. See also* Currency swap * Overnight index swap * Foreign exchange market * Interest rate swap READ MORE - FOREX SWAP ### SHIPPING ShippingFrom Wikipedia, the free encyclopediaJump to: navigation, searchMerge arrow It has been suggested that this article or section be merged into Transport. (Discuss)image:title_transport.jpgThis article is partof the Transport seriesModes...Animal-poweredAviationCableHuman-poweredPipelineShipSpaceRailRoadSee also...Topics PortalThis box: view • talk • editThe Panama canal. A cargo ship transiting the Gatún locks northbound is guided carefully between lock chambers by "mules" on the lock walls to either side.The Panama canal. A cargo ship transiting the Gatún locks northbound is guided carefully between lock chambers by "mules" on the lock walls to either side.This article is about a basic concept of transport. For other uses, see Shipping (disambiguation).Shipping is physical process of transporting goods and cargo. Virtually every product ever made, bought, or sold has been affected by shipping. Despite the many variables in shipped products and locations, there are only three basic types of shipments: land, air, and sea.Land or "ground" shipping can be either by train or by truck. Trucking is easily the most popular form of shipping. Even in Air and Sea shipments, ground transportation is still required to take the product from its origin to the airport or seaport and then to its destination. Ground transportation is typically more affordable than air shipments, but more expensive than shipping by sea. Trucks are also much faster than ships and rail but slower than planes.Many trucks will take freight directly from the shipper to its destination in what is known as a door to door shipment. Vans and trucks of all sizes make deliveries to sea ports and air ports where freight is moved in bulk also.Harbor cranes unload cargo from a container ship at the Jawaharlal Nehru Port, Navi Mumbai, IndiaHarbor cranes unload cargo from a container ship at the Jawaharlal Nehru Port, Navi Mumbai, IndiaMuch shipping is done aboard actual ships. An individual nation's fleet and the people that crew it are referred to its "merchant navy" or "merchant marine". Merchant shipping is essential to the world economy, carrying the bulk of international trade. The ships are also extremely expensive constructions themselves, being some of the largest man-made vehicles ever. The term originates with the shipping trade of wind power ships, and has come to refer to the delivery of cargo and parcels of any size above the common mail of letters and postcards.Ground shipping can be cheaper and less restrictive to size, quantity, weight, and type of freight than by air transport. Air transport is usually reserved for products which must be sent within a shorter time frame. Some carriers offer ground shipping that operates on an exact timeline as air does. This is a recent development becoming mainstream among major carriers since the late 1990s. UPS and FedEx both offer guaranteed day ground shipping.Shipping can more generally refer to the transport of freight ("shipments"), independent of the mode of transport. Billing methods* Main article: IncotermThe most common trading terms used in shipping goods internationally are:* Freight on Board OR Free On Board (FOB): freight on board means that the exporter delivers the goods at the specified location. Example, FOB Kunming Airport (the exporter delivers the goods at Kunming airport). This means exporter is bound to deliver the goods at the Kunming Airport at his cost and expenses. In the case, the freight and other expenses for outbound traffic is borne by the importer.* Cost and Freight (C&F,CFR, CNF): (With insurance payable by the importer). The exporter pays the ocean shipping/air freight costs to the specified location. Example, C&F Los Angeles (the exporter pays the ocean shipping/air freight costs to Los Angeles). Many of the shipping carriers (such as UPS, DHL, FEDEX) offer guarantees on their delivery times. These are known as GSR guarantees or "guaranteed service refunds". This means that if the parcels are not delivered on time, the customer is entitled to a refund on the shipping cost. UPS, DHL and FEDEX make it difficult however for customers to determine which parcels are late and request their refunds, and thereby allow approximately 90% of potential refunds to go unclaimed. That amounts to over$1 billion USD per year in unclaimed refunds.* Cost, Insurance, and Freight (CIF): Insurance, and Freight are all paid by the exporter to the specified location. Example, CIF Los Angeles (the exporter pays the ocean shipping/air freight costs to Los Angeles including the insurance).
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### TRANSHIPPMENT

TransshipmentFrom Wikipedia, the free encyclopediaJump to: navigation, searchTransshipment or Transhipment is the shipment of goods to an intermediate destination, and then from there to yet another destination.One possible reason is to change the means of transport during the journey (for example from ship transport to road transport), known as transloading. Another reason is to combine small shipments into a large shipment, dividing the large shipment at the other end. Transshipment usually takes place in transportation hubs. Much international transshipment also takes place in designated customs areas, thus avoiding the need for customs checks or duties, otherwise a major hindrance for efficient transport.Note that transshipment is generally considered as a legal term. An item handled (from the shipper's point of view) as a single movement is not generally considered transshipped, even though it may in reality change from one transport to another at several points. Previously it was often not distinguished from transloading since each leg of such a trip was typically handled by a different shipper.Transshipment is normally fully legitimate and an everyday part of the world's trade. However, it can also be a method used to disguise intent, as is the case with illegal logging, smuggling or grey market goods.
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### RESERVE CURRENCY

Reserve currencyFrom Wikipedia, the free encyclopediaJump to: navigation, searchThe US dollar and the euro are by far the most used currencies in terms of global reserves, making up 90% of all reserves globally. The US dollar and the euro are by far the most used currencies in terms of global reserves, making up 90% of all reserves globally.The US dollar and the euro are by far the most used currencies in terms of global reserves, making up 90% of all reserves globally.A reserve currency (or anchor currency) is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the international pricing currency for products traded on a global market, such as oil, gold, etc.This permits the issuing country to purchase the commodities at a marginally cheaper rate than other nations, which must exchange their currency with each purchase and pay a transaction cost. (For major currencies, this transaction cost is negligible with respect to the price of the commodity.) It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.Contents[hide]* 1 Global currency reserves * 2 History * 3 Theory * 4 United States dollar * 5 Euro * 6 Pound sterling * 7 Other notable reserve currencies * 8 See also * 9 References Global currency reservesCurrency composition of official foreign exchange reserves ↓ '95 ↓ '96 ↓ '97 ↓ '98 ↓ '99 ↓ '00 ↓ '01 ↓ '02 ↓ '03 ↓ '04 ↓ '05 ↓ '06 ↓ '07 ↓US dollar 59.0% 62.1% 65.2% 69.3% 70.9% 70.5% 70.7% 66.5% 65.8% 65.9% 66.4% 65.7% 63.3%Euro 17.9% 18.8% 19.8% 24.2% 25.3% 24.9% 24.3% 25.2% 26.5%German mark 15.8% 14.7% 14.5% 13.8% Pound sterling 2.1% 2.7% 2.6% 2.7% 2.9% 2.8% 2.7% 2.9% 2.6% 3.3% 3.6% 4.2% 4.7%Japanese yen 6.8% 6.7% 5.8% 6.2% 6.4% 6.3% 5.2% 4.5% 4.1% 3.9% 3.7% 3.2% 2.9%French franc 2.4% 1.8% 1.4% 1.6% Swiss franc 0.3% 0.2% 0.4% 0.3% 0.2% 0.3% 0.3% 0.4% 0.2% 0.2% 0.1% 0.2% 0.2%Other 13.6% 11.7% 10.2% 6.1% 1.6% 1.4% 1.2% 1.4% 1.9% 1.8% 1.9% 1.5% 1.8% Sources: 1995-1999, 2006-2007 IMF: Currency Composition of Official Foreign Exchange ReservesPDF (80 KB)Sources: 1999-2005, ECB: The Accumulation of Foreign ReservesPDF (816 KB) v • d • e Percentage of global currenciesPercentage of global currencies HistoryBy some definitions reserve currencies have existed for millennia. These currencies were widely recognized and used for international transactions. However, the modern conception of an international currency as a store of value for the international reserves of central banks and governments is a relatively recent development, arising only in the 19th century coinciding with the emergence of the international gold standard in the decades leading up to the First World War.After World War II, the international financial system was governed by a formal agreement, the Bretton Woods System. Under this system the US dollar was placed deliberately at the centre of the system, with the US government guaranteeing other central banks that they could sell their US dollar reserves at a fixed rate for gold if they so desired. European countries and Japan deliberately devalued their currencies against the dollar in order to boost exports and development.In the late 1960s and early 70s the system came apart under pressure from the rising prominence of the other countries, as well as growing deficits in the US. The US dollar remained central due to the lack of competitor currencies.Recently, nations, especially in Asia, have been stockpiling reserves at levels previously unknown, especially in US dollars, in an effort to strengthen export competitiveness by weakening their own currencies, and also to contain quick and large inflows of capital and buffer against financial crisis such as the Asian financial crisis. TheoryEconomists debate whether or not a single reserve currency will always dominate the global economy.[1] Many have recently argued that one currency will almost always dominate due to network externalities, especially in the field of invoicing trade and denominating foreign debt securities, meaning that there are strong incentives to conform to the choice that dominates the marketplace. The argument is that, in the absence of sufficiently large shocks, a currency that dominates the marketplace will not lose much ground to challengers.However, some economists, such as Barry Eichengreen argue that this is not as true when it comes to the denomination of official reserves because the network externalities are not strong. As long as the currency's market is sufficiently liquid, the benefits of reserve diversification are strong, as it ensures against large capital losses. The implication is that the world may well soon begin to move away from a financial system dominated uniquely by the dollar. In the first half of the 20th century multiple currencies did share the status as primary reserve currencies. Although Sterling was the largest currency, both francs and marks shared large portions of the market until the First World War, after which the mark was replaced by dollars. Since the Second World War, the dollar has dominated official reserves, but this is likely a reflection of the unusual domination of the American economy during this period, as well as official discouragement of reserve status from the potential rivals, Germany and Japan. United States dollar This section does not cite any references or sources.Please help improve this section by adding citations to reliable sources. Unverifiable material may be challenged and removed. (December 2007)The United States dollar is the most important reserve currency in the world today. Throughout the last decade, an average of two thirds of the total allocated foreign exchange reserves of countries have been in U.S. dollars. For this reason, the U.S. dollar is said to have "reserve-currency status", making it somewhat easier for the United States to run higher trade deficits with greatly postponed economic impact (see currency crisis). Central bank reserves held in dollar-denominated debt, however, are relatively small compared to private holdings of such debt. If foreign holders of dollar-denominated assets decided to shift holdings to assets denominated in other currencies, there could be serious consequences for the U.S. economy. Changes in the structure of the international financial system, however, typically occur only gradually. Thus, a large, sudden shift away from dollar reserve holdings is unlikely. EuroThe euro is currently the second most commonly held reserve currency, being approximately a quarter of allocated holdings. After World War II and the rebuilding of the German economy (see the Wirtschaftswunder), the German Deutsche Mark gained the status of the second most important reserve currency after the US dollar. When the euro was launched in 1999, replacing the Mark and other European currencies, it inherited the status of a major reserve currency from the Mark. Since then its contribution to official reserves has risen continually as banks seek to diversify their reserves and trade in the eurozone continues to expand.[2] The New York Times Book Review also referred to the euro as the "Deutsch-Mark by another name".Former Federal Reserve Chairman Alan Greenspan said in September 2007 that the euro could replace the U.S. dollar as the world's primary reserve currency. It is "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency."[3] Econometrical analysis suggests, the euro may replace the U.S. dollar as the major reserve currency by 2020 if: (1) the remaining EU members, including the UK, adopt the Euro by 2020 or (2) the recent depreciation trend of the dollar persists into the future.[4] Pound sterlingThe United Kingdom's pound sterling was the primary reserve currency of much of the world in the 18th and 19th centuries. The dire economic cost of fighting the First and Second World Wars, the increasing dominance of the USA in world economics (and, importantly, the establishment of the American Federal Reserve Bank in 1913) as well as economic weakness in the UK at various intervals during the second half of the 20th century resulted in Sterling losing its status as the world's most reserved currency.As from mid 2006 it is the third most widely held reserve currency, having seen a resurgence in popularity in recent years.[5] Analysts say this resurgence is caused by carry-trade investors considering the pound as a stable high-yield proxy to the Euro.[6] Other notable reserve currenciesThe Japanese yen was considered as the third most important reserve currency for several decades, but has recently been on the decline and has now been overtaken by sterling.The Soviet ruble was also an important reserve currency along with the U.S. Dollar, in the Communist world, from about the 1950's up until the Soviet collapse in 1991.The Swiss franc is often said to be a reserve currency as well, due to its stability, although the share of all foreign exchange reserves held in Swiss francs is typically just around or even below 0.3%.Other nations and groups of nations have expressed their desire to see their currencies (or future currencies) be used as reserve currencies, such as Russia, People's Republic of China, and the Gulf Cooperation Council.The G8 also frequently issues public statements as to exchange rates, though with the exception of Japan, the member states are impotent in their ability to directly affect rates.[clarify] In the past, however, its predecessor bodies could directly manipulate rates to reverse large trade deficits (see Plaza Accord).The top reserve currency is generally selected by the banking community for the strength and stability of the economy in which it is used. Thus, as a currency becomes less stable, or its economy becomes relatively less dominant, bankers may over time abandon it for a currency issued by a larger or more stable economy. This can take a relatively long time, as recognition is important in determining a reserve currency. For example, it took many years after the United States overtook the UK as the world's largest economy before the dollar overtook Sterling as the dominant global reserve currency
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### BALANCE OF TRADE

Balance of tradeFrom Wikipedia, the free encyclopediaJump to: navigation, searchThe balance of trade encompasses the activity of exports and imports, like the work of this cargo ship going through the Panama Canal.The balance of trade encompasses the activity of exports and imports, like the work of this cargo ship going through the Panama Canal.The balance of trade (or net exports, sometimes symbolized as NX) is the difference between the monetary value of exports and imports in an economy over a certain period of time. A positive balance of trade is known as a trade surplus and consists of exporting more than is imported; a negative balance of trade is known as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided into a goods and a services balance; especially in the United Kingdom the terms visible and invisible balance are used.Contents[hide]* 1 Definition * 2 Economic impact o 2.1 Against trade deficit o 2.2 Pro-trade deficit * 3 Milton Friedman on trade deficits * 4 Physical balance of trade * 5 United States trade deficit * 6 See also * 7 Notes * 8 External links DefinitionThe balance of trade forms part of the current account, which also includes other transactions such as income from the international investment position as well as international aid. If the current account is in surplus, the country's net international asset position increases correspondingly. Equally, a deficit decreases the net international asset position.The trade balance is identical to the difference between a country's output and its domestic demand (the difference between what goods a country produces and how many goods it buys from abroad; this does not include money re-spent on foreign stocks, nor does it factor the concept of importing goods to produce for the domestic market).Measuring the balance of payments can be problematic because of problems with recording and collecting data. As an illustration of this problem, when official data for all the world's countries are added up, exports exceed imports by a few percent; it appears the world is running a positive balance of trade with itself. This cannot be true, because all transactions involve an equal credit or debit in the account of each nation. The discrepancy is widely believed to be explained by transactions intended to launder money or evade taxes, smuggling and other visibility problems. However, especially for developed countries, accuracy is likely.Factors that can affect the balance of trade figures include:* Prices of goods manufactured at home (influenced by the responsiveness of supply) * Exchange rates * Trade agreements or barriers * Other tax, tariff and trade measures * Business cycle at home or abroad.The balance of trade is likely to differ across the business cycle. In export led growth (such as oil and early industrial goods), the balance of trade will improve during an economic expansion. However, with domestic demand led growth (as in the United States and Australia) the trade balance will worsen at the same stage in the business cycle.Strong GDP growth economies such as the United States, the United Kingdom, Australia and Hong Kong run consistent trade deficits, as well as poorer countries also experiencing a lot of investment.Developed nations such as Canada, Japan, and Germany typically run trade surpluses. China also has a trade surplus. A higher savings rate generally corresponds with a trade surplus. Correspondingly, the United States with its negative savings rate consistently has high trade deficits. Economic impactModern economists are split on the economic impact of the trade deficit with opponents viewing it as a long run drag on GDP and employment with high social costs while proponents claim it is a sign of economic strength. Against trade deficitSome economists believe that GDP and employment[1][2] can be dragged down by an over-large deficit over the long run.[3][4]Those who ignore the effects of long run trade deficits may be confusing the David Ricardo's principle of comparative advantage with Adam Smith's principle of absolute advantage, specifically ignoring that latter. The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile.[5] [6] Free trade concepts presume free floating currencies; however, in the real world, currencies such as China's are not free floating, while others may be manipulated by governments.Since the stagflation of the 1970s, the U.S. economy has been characterized by slower GDP growth. In 1985, the U.S. began its growing trade deficit with China. Over the long run, nations with trade surpluses tend also to have a savings surplus while the U.S. has been plagued by persistently lower savings rates than its trading partners which tend to have trade surpluses with the U.S. Germany, France, Japan, and Canada have maintained higher savings rates than the U.S. over the long run. In 2006, the primary economic concerns have centered around: high national debt ($9 trillion), high non-bank corporate debt ($9 trillion), high mortgage debt ($9 trillion), high financial institution debt ($12 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position (NIIP) (-24% of GDP),[7] high trade deficits, and a rise in illegal immigration.[8][9] These issues have raised concerns among economists and unfunded liabilities were mentioned as a serious problem facing the United States in the President's 2006 State of the Union address.[citation needed] Pro-trade deficitThose who defend deficits revert to explanations of comparative advantage. Buyers in the receiving country send the money back. A firm in America sends dollars for Brazilian sugarcane, and the Brazilian receivers use the money to buy stock in an American company. This may lead to profits leaving the U.S however as Americans may forfeit control. Although this is a form of capital account reinvestment, it may not be a liability on anyone in America.Such payments to foreigners have intergenerational effects: by shifting the consumption schedule over time, some generations may gain and others lose [10]. However, a trade deficit may incur consumption in the future if it is financed by profitable domestic investment, in excess of that paid on the net foreign debts. Similarly, an excess on the current account shifts consumption to future generations, unless it raises the value of the currency, detering foreign investment.However, trade inequalities are not natural given differences in productivity and consumption preferences. Trade deficits have often been associated with international competitiveness. Trade surpluses have been associated with policies that skew a country's activity towards externalities, resulting in lower standards. An example of an economy which has had a positive balance of payments was Japan in the 1990s.Milton Friedman and Dewly Tiwana argued that trade deficits are not important as high exports raise the value of the currency, reducing aforementioned exports, and visa versa for imports, thus naturally removing trade deficits not due to investment. This opinion is shared by David Friedman, who has said that they are 'fossil economics', based on ideas obsolete since David Ricardo.[11] Milton Friedman on trade deficitsCurrent account balance 2006Current account balance 2006[12]Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting[13] industries. He stated his belief that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation.However, Friedman's argument may have been a short term argument that has not proven valid in the long run. It is equivalent to saying that it doesn't matter if you get indebted, because eventually you will have to pay the money back. The obvious counterargument is that once a significant debt has been accumulated, paying it back may be painful. Friedman's supporters retort that when the money returns, the demand for foreign currency will make the exchange rate better for trade deficit country. Additionally, Friedman opposed large-scale borrowing to fuel consumption. He argued that a balance of payments deficit was a symptom of this, and that if it was caused by incoming investment, it was not a bad thingThose who assert Friedman's view as if it were a long run view may be ignoring the intergenerational or long run consequences of deficits, low savings, and borrowing to fund consumption. If country A has a trade deficit because of large imports of consumer goods, other countries accumulate cash from country A. That money can be used to purchase existing investment assets and government bonds within country A. As a result, the return from those assets will accrue not to citizens of country A but to foreigners. The consumption standard of future generations in country A may therefore potentially decline as a result of the deficit. In particular, Americans are increasingly paying taxes to finance the interest on federal bonds held by foreigners. However, a criticism of this argument notes that all transactions are win-win. In the case of foreign investment in American assets, it helps fuel American economic growth and keeps US interest rates low. This argument is more appealing in the case of foreign direct investment, and less obvious when foreigners simply purchase the existing stock of assets.Friedman also believed that deficits would be corrected by free markets as floating currency rates rise or fall with time to encourage or discourage imports in favor of the exports, reversing again in favor of imports as the currency gains strength. A potential difficulty however is that currency markets in the real world are far from completely free, with government and central banks being major players, and this is unlikely to change within the foreseeable future. Nevertheless, recent developments have shown that the global economy is undergoing a fundamental shift. For many years the U.S. has borrowed and bought while in general, the rest of the world has lent and sold. However, as Friedman predicted, this paradigm appears to be changing.As of October 2007, the U.S. dollar has grown weaker against the euro, British pound, and many other currencies. For instance, the euro hit \$1.42 in October 2007[14], the strongest it has been since its birth in 1999. Against this backdrop, American exporters are finding quite favorable overseas markets for their products and U.S. consumers are responding to their general housing slowdown by slowing their spending. Furthermore, China, the Middle East, central Europe and Africa are absorbing more of the world's imports which in the end may result in a world economy that is more evenly balanced. All of this could well add up to a major readjustment of the U.S. trade deficit, which as a percentage of GDP, began in 1991.[15]Friedman and other economists have also pointed out that a large trade deficit (importation of goods) signals that the country's currency is strong and desirable. To Friedman, a trade deficit simply meant that consumers had opportunity to purchase and enjoy more goods at lower prices; conversely, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received.Perhaps most significantly, Friedman contended strongly that the current structure of the balance of payments is misleading. In an interview with Charlie Rose, he stated that "on the books" the US is a net borrower of funds, using those funds to pay for goods and services. He pointed to the income receipts and payments showing that the US pays almost the same amount as it receives: thus, U.S. citizens are paying lower prices than foreigners for capital assets to exchange roughly the same amount of income. The reasons why the U.S. (and UK) appear to earn a higher rate of return on their foreign assets than they pay on their foreign liabilities are not clearly understood. An important contributing factor is that the U.S. has investment primarily in stocks abroad, while foreigners have invested heavily in debt instruments, such as U.S. government bonds [16]. [17] Other reports contend that U.S. net foreign income has deteriorated, and appears set to stay in deficit in the future [18].Friedman presented his analysis of the balance of trade in Free to Choose, widely considered his most significant popular work. Physical balance of tradeMonetary balance of trade is different from physical balance of trade (which is expressed in amount of raw materials). Developed countries usually import a lot of primary raw materials from developing countries at low prices. Often, these materials are then converted into finished products, and a significant amount of value is added. Although for instance the EU (as well as many other developed countries) has a balanced monetary balance of trade, its physical trade balance (especially with developing countries) is negative, meaning that in terms of materials a lot more is imported than exported. United States trade deficitThe United States has posted a trade deficit since the 1970s since the end of the so-called gold standard, and it has been rapidly increasing since 1997 [19] (see chart below). The US trade deficit hit a record high of 817.3 billion dollars in 2006, up from 767.5 billion dollars in 2005.[20]It is worth noting on the graph that the deficit slackened during recessions and grew during periods of expansion. Also of note, many economists calculate trade deficits and/or current account deficits as a percentage of GDP. The U.S. last had a trade surplus in 1991, a recession year. Every year there has been a major reduction in economic growth, it is followed by a reduction in the US trade deficit. [15]Warren Buffett has proposed a tool called Import Certificates as a solution to the United States' problem.
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