INB 205 Wk 2 Assignment - Foreign Exchange Markets Summary - 80 of 100
INB 205 Wk 2 Assignment - Foreign Exchange Markets Summary - 80 of 100
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Date Created: 11/16/15
Foreign Exchange Markets 1 You did a good job discussing the gold standard and narrating positive and negative aspects of using a gold standard. However, in your analysis of the foreign exchange markets, you did not discuss the International Monetary Fund, Explain the purpose of the World Bank and its International Finance Corporation nor did you Identify the world’s major foreign currency exchange (Fx) markets of the world ( 20 points). GRADE: 80/100 Foreign Exchange Markets Summary Your name Axia College University of Phoenix Foreign Exchange Markets 2 Abstract Gold has been found and extracted on all continents. Throughout history gold has been a symbol of value, a method of payment, and a means of ostentation. Although not currently used by any government, the gold standard established a form of monetary equalization, has been replaced by the fiat money system. Foreign Exchange Markets 3 Foreign Exchange Markets Brief History of Gold Although primarily used for personal adornment, early Egyptian Kings did issue some gold coins between the fourth to sixth dynasties. King Croesus issued the first gold coin stamped with his royal emblem on a largescale in ancient Lydia from 560546 B.C. The worldwide trade and commerce standard of exchange was eventually based off King Croesus coins. In 546 B.C. the collapse of the Lydian Empire allowed the Persians to gain control of Asia’s gold. Named after Darius the Great, the daric became the Persian Empires standard gold coin between 521 486 B.C. Alexander the Greats conquest of Persia established a system of coinage for Macedonia between 336 323 B.C. that eventually moved into Europe; allowing Emperor Augustus to establish a gold currency known as the aureus between 31 B.C. and A.D. 14; which helped expand the Roman economy. By the 5th century when the Roman Empire collapsed gold had been used for many hundreds of years. Gold became so desirable that by 1521 “Europeans began to finance expeditions in search of the great source of gold” (The Federal Reserve Bank of New York, 2004). The Gold Standard The Coinage Act of 1792 set the official price of gold at $19.75 a troy ounce; creating the gold standard. The gold standard is a “monetary system under which a nation’s currency may be converted into bills of exchange drawn on a country whose currency is convertible into gold at a stable rate of exchange” (Encyclopædia Britannica Online, 2009). In other words this means the Foreign Exchange Markets 4 government can only print as much money as its country has in gold. The gold standard required participating countries to give absolute priority to external adjustment over domestic objectives. Great Britain which had defined its currency primarily in terms of gold since 1717 became the first modern nation to link its money to gold. The United States adopted the gold standard in 1900 with the passage of the Gold Standard Act. As confidence increased more nations adopted the gold standard, and by 1914 a large number of countries had accepted the system. Advantages of the Gold Standard Advantages of the gold standard include creating a certainty in international trade. A fixed rate of exchange for paper currency provided a fixed pattern of exchange rates. Also, limiting the power of governments or banks by limiting the issuance of paper currency reduces the risk of price inflation. Disadvantages of the Gold Standard Disadvantage of the gold standard are: A country's supply of gold determines the size and health of economy; Large fluctuations in the economy can be caused by the Government’s actions to protect gold reserves; and A country keeping its gold can become an obsession instead of the country concentrating on improving the business climate (Amadeo, 2009). Maintaining the Gold Standard During World War I, and most all wars since, few nations could maintain the gold standard due to the excess printing of money to cover the cost of the war. In the late 1920s when Foreign Exchange Markets 5 the standards were restored a revised version called the gold exchange standard was adopted by many countries. Under the goldexchange standard system the value of currency is fixed by how much gold it can be exchanged for. The goldexchange standard system was put in place by the leaders of the allied nations in 1944 in Bretton Woods, New Hampshire as a way to set up a stable economy after World War II. According to The Federal Reserve Bank of New York (n.d.) there were many advantages of the goldexchange system: It served as a common measure of value It helped keep inflation in check by keeping money supply in the goldexchange standard economies fairly stable Longterm planning was easier as rate changes were infrequent. After concerns that the U.S. did not have enough gold to pay for the amount of printed dollars held by foreigners the goldexchange standard began to weaken in the 1960s (The Federal Reserve Bank of New York, n.d.). In 1971, with steadily falling gold reserves, President Nixon decided to abandon the Bretton Woods system and announced that U.S. would no longer be using the goldexchange standard or converting dollars into gold. The system that exist today of floating exchange was established by 1973. After the goldexchange standard was abandoned, “the foreign exchange market went from a relatively unimportant financial specialty to the forefront of international economics” (The Federal Reserve Bank of New York, n.d.). Foreign Exchange Markets 6 With the abandonment of the goldexchange standard a new method of exchange was required, creating the fiat money system. The United States first used fiat money in 1862. Greenbacks were used as a tool to pay for the enormous cost of the Civil War. “Greenbacks were a debt of the U.S. government, redeemable in gold at a future unspecified date. They were circulated along with Gold certificates, backed by the government’s promise to pay in gold” (Kwaves.com, 2004). In a fiat money system, money is not backed by gold; its only value is its scarcity and the faith placed in it by the people using it. Excessive public debt in most cases causes a government to create a fiat monetary system. The temptation to remove physical backing becomes irresistible when governments are unable to repay all the debts it owes. By switching to the fiat system there is no limit to the amount of money the government can print. This lack of limit however, can cause hyperinflation. “Hyperinflation is often the result of increasing regular inflation to the point where all confidence in money is lost. [T]he value of money is based on confidence, and once that confidence is gone, money irreversibly becomes worthless, regardless of its scarcity” (Kwaves.com, 2004). For the past 3000 years gold has replaced every fiat currency. The United States has avoided hyperinflation over the past 200 years by switching between a fiat system and gold standard system (Kwaves.com, 2004). Although the gold standard helps to prevent inflation it also helps to regulate the price of our currency and the exchange rate across nations. Many factors affect the currency exchange rate, but in reality supply and demand affect currency price. Foreign Exchange Markets 7 References Amadeo, K. (2009). How Would a Return to the Gold Standard Affect the U.S. Economy? Retrieved July 25, 2009, from http://useconomy.about.com/od/monetarypolicy/p/gold_standard.htm Encyclopædia Britannica Online. (2009). goldexchange standard. Retrieved July 22, 2009, from http://www.britannica.com/EBchecked/topic/237339/goldexchangestandard Kwaves.com. (2004) Fiat Money History in the US. Retrieved July 25, 2009, from http://www.kwaves.com/fiat.htm The Federal Reserve Bank of New York. (2004). The Key to the Gold Vault. Retrieved July 22, 2009, from http://www.newyorkfed.org/education/addpub/goldvaul.pdf The Federal Reserve Bank of New York. (n.d.). The Basics of Foreign Trade and Exchange. Retrieved July 23, 2009, from http://www.newyorkfed.org/education/fx/foreign.html
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