To appreciate the functions of the foreign exchange market and understand the concepts of the gold standard, further discovery of the topics are needed. First, an understanding of the role the foreign exchange markets in international business and how they impact a country’s ability to do business with foreign nations needs to be addressed. In addition to this, exploring how the value currency exchange has on the issuing country will help us to uncover the functions of the foreign exchange market. The gold standard plays an important role in international business and affects how countries due business with one another. Weighing the positive and negative aspects of the gold standard will help define its impact on international business.
To detail the functions of the foreign exchange market (FOREX), we need an understanding of what a foreign currency exchange market is, what it does, why we need it, and the benefits it has on monetary systems of all participating countries. Starting with a simple explanation given by Ball, McCulloch, Frantz, Geringer, and Minor (2006 p.166), FOREX “is a place where monies can be bought, sold, or borrowed”. FOREX locations are in various countries and cities, but the major FOREX locations are in London, New York, Tokyo, and Singapore (Ball et al., 2006).
As previously stated the FOREX provides a place for nations to purchase, borrow, or sell their own currency to members of other nations. So what does the FOREX do? FOREX provides the resources for countries to make payments and transfer funds across borders, and provides purchasing power from one currency to another (Cross, 1998). Cross explains that these provisions make valuations of currency available to determine one of the greatest functions of the FOREX, the exchange rate.
The exchange rate, as determined by Cross (1998), is “a price determined by the number of units of one nation’s currency that must be surrendered in order to acquire one unit of another nation’s currency”. Cross continues to explain that the exchange rate between two currencies is dependent upon official or private participants to buy and sell its currency to maintain an authorized pegged rate. The exchange rates in FOREX are set then by the market and not by governments (Ball et al., 2006), thus referred to as the floating currency exchange rate. Other approaches to determining the exchange rate like the purchasing power parity (PPP) theory which states that exchange rates in the long run will adjust to equalize the purchasing power of differing currencies (Ball et al., 2006). Therefore, products in competitive markets will sell for identical prices when valued in the same currency (Cross, 1998). The PPP relies on a portion of another approach in determining exchange rates, balance of payments (BOP). BOP approach relies on assessing foreign exchange flows and evaluating balance of payments on current and capital accounts (Cross, 1998). Even with these determinations, the biggest player in defining the exchange rates rely on supply and demand of American goods and currency.
International business relies directly on the functionality of the FOREX. In addition to international business, citizens traveling to foreign nations have to a standard in which they can pay for foreign goods and services. FOREX make these situations possible. As we know, every nation has its own currency and monetary system. The FOREX makes it possible for U.S. citizens to travel to foreign nations and by goods and services in forms acceptable to foreigners (Cross, 1998). Whether the business in the foreign country accepts the dollar at a determined exchange rate or the U.S. citizen exchanges their dollars at a bank for a foreign currency, business transactions can be made. The same can be said for foreign businesses investing in American owned companies or vice versa, cross boarder purchases and investments are able to be made.
The international use of currency creates many benefits to issuing countries. First, it obtains profit from minting coins, because the noninterest-bearing claims on it are expressed in its own currency and is able to do this by unexpectedly inflating its currency (Tavlas, 1998). Second, as Tavlas states, “… as the international use of a currency expands, loans, investments, and purchases of goods and services will increasingly be executed through the financial institutions of the issuing country”. Thus, we can say that another function of FOREX is the participation in the growth of developing nations; helping to eliminate poverty and internationalize their goods and services.
The Gold Standard
A gold standard is a system in which countries agree to buy and sell gold at a defined number of currency units (Ball et al., 2006). This, in effect, created the exchange rate between nations currency by taking the difference between the currency determinations and creating a product that would be valued the same if the currencies were identical (Ball et al., 2006). There are positive and negative aspects of using a gold standard.
One positive aspect to a gold standard is that a government could not print currency that was not backed by gold (Ball et al., 2006), thus, keeping financial stability. In addition to this stability, it would control inflation by not allowing the issuance of large amount of currency (Fortune, 1996). Having a gold standard also creates a convertible currency, meaning that currency could be cashed in for its gold equivalent. Fortune also points out that some believe that a gold standard would create a stable international monetary standard for all nations.
Negative impacts on the gold standard include the fluctuating rates of gold and federal interest rate. Fortune (1996) states “the price of gold popped up about 8% not long ago before falling back, so if a gold rule had been in effect, the Fed would have hoisted interest rates higher instead of cutting them as it’s been doing. Fortune contends that these high rates would cause not only a recession, but a market plunge. Another negative aspect to the gold standard is that current monetary systems around do not have enough storable gold to cover its current currencies.
Conclusion
As we have explored, FOREX has many different functions, but most importantly, allows international business to be a reality. Without FOREX trade, investments, and purchases could not be possible. It would be left to the negotiations of individual nations to barter goods to receive goods. Foreign direct investments would be unrealistic as well as the outsourcing of manufactured products. FOREX has proven to be valuable to the international community. The possibility for exchange market came from the gold standard which allowed nations to develop exchange rates between currencies and conduct business with foreign nations. Although we do not use a gold standard to define the exchange rates between nations and there are many positive and negative aspects to having a gold standard, it has played a vital role in how FOREX has developed.
Ball, D. A., McCulloch, Jr., W. H., Frantz, P. L., Geringer, J. M., & Minor, M. S. (2006). Understanding the International Monetary System. In International Business: the Challenge of Global Competition (10th ed., pp. 144-174). New York: McGraw-Hill.
Cross, S. Y. (1998). The foreign Exchange Market in the United States [Electronic version]. New York: Federal Reserve Bank of New York.
Fortune. (1996, March). Good as Gold? Fortune Magazine, 133(5), 42. Retrieved March 1, 2008, from ABI/INFORM Global database (9297867).
Tavlas, G. S. (1998, June). The International use of Currencies: the U.S. Dollar and the Euro. Finance and Development, 35(2), 46-49. Retrieved March 1, 2008, from General OneFile. Gale. Apollo Library database (A20860207).
