International Financial Markets
The term "International Financial Markets" is generally, albeit not always, applied to the various exchanges of foreign currency and currency-linked derivatives, plus the international bond market. These markets emerged after the Bretton Woods System collapsed in the early 1970s. The Bretton Woods System had pegged most free market currencies to the United States dollar, which in turn had been linked to gold. However, once currencies were allowed to float in value relative to one another, it was possible to trade them and derivatives based on them (futures, spots, etc.) in much the same way that other commodities may be traded. These new international markets include the Foreign Exchange (FX) market, the Eurocurrency market, and international or Eurobond market (among others). Basic knowledge of these markets is, thus, vital to anyone doing business either international or, given the increasingly globalized nature of commerce, within a single nation.
Keywords Bretton Woods; Currency; Derivatives; Eurrocurrency; Foreign exchange (FX); Forward; Futures; International Finance; Options; Spot
International Business: International Financial Markets
The term "International Financial Markets" is generally applied to the various exchanges of foreign currency and currency-linked derivatives, plus the international or Eurobond market. It should be noted, though, that this nomenclature, while common, is not universal, and some writers will use the term to mean anything from the world's stock exchanges to the money changers of third world villages. That said, "International Financial Markets" will be used in this article to mean the global Foreign Exchange (FX), Eurocurrency, and Eurobond markets.
Foreign Currency Exchange
The Foreign Currency Exchange (FX) market can be broadly defined as the decentralized network in which currency traders located across the world buy and sell the money of different nations.
The Eurocurrency Market is the similarly decentralized market for "Eurocurrency," that is, deposits in a bank in one country which are denominated in the currency of another country.
The Eurobond Market, finally, is the market for Eurobonds, that is, bonds denominated in the currency of a particular nation, but which are not sold in that nation. Thus, a Eurobond might be issued in American dollars, but by a bank outside of the United States, and sold exclusively in Asia.
These markets are vitally important to anyone doing business, anyplace, in the world today. In an age when raw material suppliers and final customers are almost certainly located in different nations, and when a "single" product may contain parts from many different countries, the reality is that all trade is multinational trade. The price of any one item in any one location will then be dependent on the purchasing power of the currency used to pay for it. That purchasing power, in turn, will depend on the currency's standing in the International Financial Markets.
While International Financial Markets have existed in some form since merchants discovered there was a profit to be made in buying and selling the coinages of different weights and purities issued by different princes, they developed their present form only quite recently-literally less than two generations ago, with the demise of the Bretton Woods System in the early 1970s. The Bretton Woods Systems was brought into existence in the aftermath of World War II by the Western Allied powers, chiefly the United States and the United Kingdom. At that time, the world's major powers, or at least those involved in the free market economy, were particularly concerned with stability. The recent world war and the Great Depression before it seemed to prove that some form of currency regulation was necessary to keep national economies from spiraling into debt, crisis, inflation, and ultimately, dictatorship and war.
Bretton Woods Agreement
The Bretton Woods agreements (so called because they were drawn up at a conference held in Bretton Woods, New Hampshire in 1944) specified that free market world currencies would be pegged to the dollar, which in turn would be pegged to gold. In effect, this allowed British Pounds, U.S. Dollars, West German Marks, Japanese Yen, and so on, to be freely convertible with one another, thus facilitating international trade. But, because these were all ultimately linked to gold, their value was more or less stable (Cohen, 2001).
The Bretton Woods System worked chiefly because at the time, the U.S. economy was enormously strong compared to every other on the planet, raw materials (and particularly oil) were relatively cheap, and the volume of international trade was relatively small. In the late 1940s and early 1950s, no one could have possibility foretold that German and Japanese cars and electronics, Chinese textiles and South American low-cost labor would someday compete with America's factories and mills. Moreover, if anyone had suggested that gasoline would be more costly than distilled water, that person would surely have been dismissed as an alarmist.
Failure of the Bretton Woods System
In the 1970s, all those things had come to pass. The American dollar was under enormous inflationary pressure, oil prices had skyrocketed, and international trade was now far too large for any one economy to act as a sort of world lender of last resort. Thus, by 1973, the Bretton Woods system had been largely dismantled. The dollar was no longer pegged to gold, and individual currencies floated in value against one another.
Development of the Foreign Currency Exchange Market
As a result, de facto market mechanisms soon took the place of those official mechanisms of Bretton Woods. The foreign currency exchange (FX) market was perhaps the first to draw the attention of the public. Roughly defined, it is the large (not to say enormous), decentralized, amorphous, high risk, and high volume market in which currency traders located across the world buy and sell the money of different nations. It has no one central point and no one predominant physical location. In other words, it has no equivalent to Wall Street or the City of London, but rather exists chiefly in what might be called economic cyberspace. In effect, it is the Internet of the financial world, which makes a certain sense, given that both the Internet and the modern FX market developed at roughly the same time and were similarly based on electronic communications. However, if the FX Market has no one location, it does have geographic capitals where the participants are more often based than not-i.e., the traditional banking centers, such as the United States, the United Kingdom, Germany, Japan, Singapore, Hong Kong, Switzerland, and so on. In addition, China and India have become ever more aggressive players in the market.
The FX Market can be thought of, then, as a network whose individual nodes are traders, brokers, banks, governments, pension funds, multinational corporations, speculators and more. All of these may also be "market makers," i.e., people or companies who offer to buy currencies at one price and to sell them at another (Grabbe, 1996, p. 88). Such market makers, who attempt to profit from the difference between the bid and the offer, tend to be the predominant players in FX, and it is them that one usually thinks of when one says "currency trader."
In theory, traders could deal in any of the world's many currencies, and to a certain extent, they do. However, the reality is that there is relatively...
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