A Fact Of Life
Tuesday, 2 November 2010
It is essential to understand that forex is a market that plays out in everyday life in a way that other markets do not. A fluctuation in currency value can have an impact on a nation’s social, political, and economic conditions. In extreme situations, a nation’s entire political structure can be shaken to the core.
Because of these high stakes, a government often uses all its power to control the value of its currency. It may decide that to protect its private citizens from international traders and stabilize its economy the government needs to control how its currency is traded. China, for example, has “pegged” its currency to the U.S. Dollar, meaning that it has set a tight conversion rate of $1 to 7.27 Yuan.
This peg has defied market forces, which are pushing for the Yuan to float against the dollar because of the huge trade imbalance between the two countries. But China has kept the peg, worried that simply allowing its currency to appreciate against the dollar would damage its economic growth and possibly throw its tightly monitored society into turmoil.
Japan also exercises strong control over its currency, unlike its developed counterparts, the U.S. and Europe, which allow their currencies to float more freely. At its basic level, Japan is an export driven economy that understands currency fluctuations. Exports powered Japan Inc. through the 70's and 80's.
There are two ways for an export country to stay competitive: be innovative or be cheaper than the competition. Japan had been both, and it ruthlessly grabbed market share and put American competitors out of business. In the early 90's, however, that began to change. The Yen rose in value, and even cheaper and nimbler competitors appeared in Southeast Asia. Suddenly, Japan Inc. began to lose its luster. Japanese companies, like their American competitors a decade before, were forced to send work overseas, and unemployment mounted.
Japan, however, had a tightly knit society that could not sustain these shocks. The country has since decided not to allow its currency to rise too sharply. In 2003 alone, the country intervened in markets eight times to manage its currency fluctuations. It bought billions of U.S. Dollars and sold the Yen, thereby helping control the value of the U.S. Dollar/Yen trade. Traders must realize that when they take a position on the Japanese Yen — or any other country’s currency, for that matter — they are dealing with a government that sees the value of its currency as an essential tool to protect its economic and social stability. Even a forex trader who uses purely technical to trade must beware of these unique factors and of the broader lesson that currencies are not just another investment to be traded.
If a stock plunges one day, it may be damaging to some investors. If it’s a bellwether stock, such as Intel, it might lead to a market sell-off that hits a lot of investors in the wallet. Eventually, this might play out by signaling that the economy is slowing down, with all the accompanying pains that such a slowdown brings. But unless a stock market crashes in dramatic fashion, people continue to live their lives, mostly oblivious to or uncaring whether the market is up or down from day to day.
Fluctuations in the Forex market, however, can have an immediate effect on people throughout society, no matter how rich or how poor. A change in the foreign exchange rate can mean that middle-class luxuries such as cars and houses are suddenly too expensive. A more severe change can make it difficult to feed one’s family.
Because of these high stakes, a government often uses all its power to control the value of its currency. It may decide that to protect its private citizens from international traders and stabilize its economy the government needs to control how its currency is traded. China, for example, has “pegged” its currency to the U.S. Dollar, meaning that it has set a tight conversion rate of $1 to 7.27 Yuan.
This peg has defied market forces, which are pushing for the Yuan to float against the dollar because of the huge trade imbalance between the two countries. But China has kept the peg, worried that simply allowing its currency to appreciate against the dollar would damage its economic growth and possibly throw its tightly monitored society into turmoil.
Japan also exercises strong control over its currency, unlike its developed counterparts, the U.S. and Europe, which allow their currencies to float more freely. At its basic level, Japan is an export driven economy that understands currency fluctuations. Exports powered Japan Inc. through the 70's and 80's.
There are two ways for an export country to stay competitive: be innovative or be cheaper than the competition. Japan had been both, and it ruthlessly grabbed market share and put American competitors out of business. In the early 90's, however, that began to change. The Yen rose in value, and even cheaper and nimbler competitors appeared in Southeast Asia. Suddenly, Japan Inc. began to lose its luster. Japanese companies, like their American competitors a decade before, were forced to send work overseas, and unemployment mounted.
Japan, however, had a tightly knit society that could not sustain these shocks. The country has since decided not to allow its currency to rise too sharply. In 2003 alone, the country intervened in markets eight times to manage its currency fluctuations. It bought billions of U.S. Dollars and sold the Yen, thereby helping control the value of the U.S. Dollar/Yen trade. Traders must realize that when they take a position on the Japanese Yen — or any other country’s currency, for that matter — they are dealing with a government that sees the value of its currency as an essential tool to protect its economic and social stability. Even a forex trader who uses purely technical to trade must beware of these unique factors and of the broader lesson that currencies are not just another investment to be traded.
If a stock plunges one day, it may be damaging to some investors. If it’s a bellwether stock, such as Intel, it might lead to a market sell-off that hits a lot of investors in the wallet. Eventually, this might play out by signaling that the economy is slowing down, with all the accompanying pains that such a slowdown brings. But unless a stock market crashes in dramatic fashion, people continue to live their lives, mostly oblivious to or uncaring whether the market is up or down from day to day.
Fluctuations in the Forex market, however, can have an immediate effect on people throughout society, no matter how rich or how poor. A change in the foreign exchange rate can mean that middle-class luxuries such as cars and houses are suddenly too expensive. A more severe change can make it difficult to feed one’s family.
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