Forex Reserves
Forex or the foreign exchange of currencies is now an integral part of business operations especially in this new age of globalization. Though the U.S. dollar is still the preferred in the world market, there are many U.S. companies, or dollar-earning enterprises, which are into trading their dollars for other currencies. This is to facilitate faster business transactions in foreign countries.
Most of the big international conglomerates which operate corporations and plants across the world invest in keeping different currencies. There are various companies who also earn from the fluctuations in the money market. This is done by stocking up on currencies such as the euro, the yen, and the pound. Later they sell it when their value strengthens against the U.S. dollar.
Since there is a great impact of the supply of dollar reserves on any government, forex trading and the reserves is heavily regulated. There are many individuals and companies who may only buy or sell. It might also happen that they bring in or take out of the country certain legal amounts of currency but this causes problems. This is especially for companies which have to put up a lot of cash in dollars for buying large assets and here is where forex brokers come in and assist them in raising the needed funds.
Dabbling in forex is a like dealing with equities and the market is volatile. This often requires taking action based on forecasts. When that is right, it can lead to huge profits. However, when these forecasts are wrong, they can cause big losses. The risks are enough to deter many. However, there are same uncertainties and the surprises. Apart from that, there is strategic aspect of the activity. This also attracts many to invest in buying and selling foreign currencies but the only difference is that forex brokers do not charge commissions, unlike equities brokers. Forex brokers get their earnings from the difference between the purchase price of a currency and the selling price after fluctuation.
Countries which devalue their currencies only do that when they have no other way to correct past economic mistakes. This is irrespective of whether their own or mistakes committed by their predecessors.
Devaluation does encourage exports and discourage imports. As the devaluation is manifested in a higher inflation, this temporary relief is eroded. A government can be forced into devaluation by trade deficit. Countries like Thailand, Mexico, and the Czech Republic - all devalued strongly, willingly or unwillingly, after their trade deficits exceeded 8% of the GDP. Then it can decide to devalue as part of an economic package of measures. This includes a freeze on wages, on government expenses and on fees charged by the government which is meant for the provision of public services. In extreme cases and when the government does not respond to market signals of economic distress, they will be forced to enter devaluation. International and local speculators will buy foreign exchange from the government. This is until its reserves are depleted and it has no money even to import basic staples and other necessities.
Thus when forced, the government has no choice but to devalue and buy back dearly the foreign exchange which was sold to the speculators cheaply.
In general, there are two known exchange rate systems and they are floating and the fixed exchange rate.
In the floating system, the local currency is allowed to fluctuate freely against other currencies. In this case, the exchange rate is determined by market forces within a loosely regulated foreign exchange domestic or even the international market. Such currencies need not necessarily be fully convertible. At times, some measure of free convertibility is a sine qua non.
In the fixed system of devaluation, the rates are centrally determined. This is done usually by the Central Bank or by the Currency Board. Here it supplants this function of the Central Bank and the rates are determined periodically which could be normally, daily and usually revolve around a "peg" with very tiny variations. Even in floating rate systems, Central banks intervene. This is to protect their currencies or to move them to an exchange rate deemed favorable. The market's invisible hand is often handcuffed by "We-Know-Better" Central Bankers and this ends up in disastrous and costly consequences. It is sufficient to o mention the Pound Sterling debacle in 1992 and the billion dollars made overnight by the arbitrageur-speculator Soros. This was the result of such misguided policy and hubris.
Floating rates are considered a protection against falling terms of trade:
If export prices fall or import prices surge, the exchange rate will adjust itself to reflect the new flows of currencies and then the resulting devaluation will restore the equilibrium.
Forex reserves are the most important aspects in maintaining the wealth of the country and steps like devaluation should be taken keeping in view of its effects.
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