Forex and the Global Economy

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You do not need a PhD in Economics to get a useful sense of the global economy. Before you start trading forex, you need to understand the "big picture." New traders often want to skip any review and tend to look at where a price is at the moment. This is a mistake because important clues to trading opportunities are embedded in gaining a larger perspective. The knowledge base that contributes to successful trading is not all in the charts.

Let's start with the fact that every transaction in the world is ultimately expressed in a currency. The price you paid may be in U.S. dollars, Euros, Yen, the Aussie, or the Loonie. Inevitably, in this age of globalization, the cup of coffee you purchase, the television you're watching, the computer you're using, the automobile you're driving, the shoes you're wearing all involve a chain of money exchanging hands around the world. For producers to make a product, they have to locate the suppliers and pay the manufacturers and shippers before the consumer gets to buy it in the local economy. Today globalization affects the profitability of every major international firm, and a shift in the value of the dollar can expose a major firm

Weak dollar hangs over U.S. carmakers. The sliding U.S. currency is hurting operations in Europe, a big revenue center for Ford and GM. January 16, 2005 [Reuters)


Nixon's Economy Allen J. Matusow 1998 University Press of Kansas to a significant reduction in profits. Firms such as Toyota, MercedesBenz, and Nissan all have located manufacturing plants in the United States, not only to improve their market share, but also to minimize currency exposure. For U.S. carmakers, the strenthening of the Euro has the effect of shrinking the earnings from their European operations. The earnings and net profits of almost all multinational companies are directly affected by the U.S. dollar. A recent example is Coke. Its earnings surged because of the U.S. dollar decline. Knowing about U.S. dollar trends can be an advantage for managing equity portfolios! When the dollar is trending weaker, companies that export will tend to have greater earnings. When the U.S. dollar is strong, tourism and industries related to imports will earn rewards...

The Forex Era Began in 1971

But before we go into the world of currencies, let's gain some perspective from history.

Currency trading is not new. It began thousands of years ago when coins were issued to represent an exchange medium instead of barter. The image of Caesar on a coin increased confidence in the currency and transformed the efficiency of trading. During this period the credibility of the money was based on its being backed by precious metals. The value of currencies reflected a set value of a percentage of the metal into which the money would be converted. In fact, the term dollar arose out of the historical circumstance that silver coins were minted in the town of Joachimstaler (Czech Republic). They became known as "talers." The word talers pronounced in Dutch and German sounds like the modern word dollar.

Gold became the accepted standard for calibrating the value of currencies. In the U.S. from 1900 to 1930 the convertibility of the dollar to gold was based on 1/20th of an ounce of gold. During the Roosevelt administration the ratio was changed to 1/35 of an ounce of gold, and private ownership of gold in the U.S. was banned during the Roosevelt administration. In 1946 the Brehton Woods System set gold to a fixed rate of $35 an ounce. But the U.S. dollar was still legally convertible to gold, and that promise of convertibility had great political implications for the upcoming elections.

On August 15, 1971, President Richard Nixon altered the world of money by taking the U.S. off the gold standard and eliminating the convertibility of gold. This created the era of fiat money. By 1973 gold went to $140 an ounce. It was a huge historical moment that few people now understand or remember. It is worth studying and gaining an understanding of why the U.S. decided to leave the gold standard. At that time Europeans held more than 1 trillion U.S. dollars.

The U.S. government feared the risk that at any time a substantial amount of those dollars could be convered into gold, causing severe disruption to the U.S. economy. It was politically and economically a huge risk that hung over the political horizon. Additionally, Nixon wanted to stimulate U.S. growth through a weaker dollar. As a result of Nixon's decision, the world entered a floating rate exchange system and the modern era of currency trading really began at this time. Many people have called for a return to a gold standard since that time.

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