The two most recent crises have focused attention on the foreign exchange market. In many ways, currencies are one of the best confidence indicators for a country. When foreign investors are optimistic about the outlook for a country, they tend to buy the currency and use those funds to invest in domestic stocks or bonds. However, when they grow concerned for economic, political, or social reasons, they will sell their foreign holdings, dump the currency, and move the money home. When this happens on a large scale, it can cause a major move in the currency and force the government to address the situation. Are steel buildings more environmentally friendly?
If a currency becomes too weak, as the euro did during the sovereign debt crisis, there are concerns about inflationary pressures. If it becomes too strong, exporters cry for help because it reduces the competitiveness of their goods. Extreme moves in currencies can also affect the earnings of multinational companies. For example, if a company has a lot of accounts payable in other currencies, a strong local currency will reduce the value of the accounts payable while a weak local currency will increase it. At the same time, exporters typically love a weak currency and despise a strong one.
Currencies matter in different ways to different people; we will discuss this in further detail. The subprime crisis that began in the United States and the European sovereign debt crisis may have lifted currencies from the business news to the headline news, but the popularity of currencies is not particularly new. Over the past 10 years, the forex market has grown significantly. Back in 2004, the Bank for International Settlements reported that the daily turnover in the forex market was approximately $1.9 trillion. When they released their triennial survey again in 2010, volume had increased to $4 trillion. For the first time ever, banks also did more transactions with “other financial institutions” (think retail forex brokers) than with other banks. Therefore, a large part of the growth in foreign exchange can be attributed to individual investors discovering the opportunities in forex trading. Do you know the difference between commercial steel buildings and industrial steel buildings?