Foreign Currency Markets and Exchange Rates

Introduction Definitions and Basics

●      Foreign Exchange, from the Concise Encyclopedia of Economics

●      The foreign exchange market is the market in which foreign currency–such as the yen or euro or pound–is traded for domestic currency–for example, the U.S. dollar. This “market” is not in a centralized location; instead, it is a decentralized network that is nevertheless highly integrated via modern information and telecommunications technology….

●      Exchange Rates, from the Concise Encyclopedia of Economics

●      Under the “floating” exchange rates we have had since 1973, exchange rates are determined by people buying and selling currencies in the foreign-exchange markets….

●      Floating and Fixed Exchange Rates, from

●      There are two ways the price of a currency can be determined against another. A fixed, or pegged, rate is a rate the government (central bank) sets and maintains as the official exchange rate….

●      Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand….

In the News and Examples

●      Monetary Union, from the Concise Encyclopedia of Economics

●      When economists such as Robert Mundell were theorizing about optimal monetary unions in the middle of the twentieth century, most people regarded the exercise as largely hypothetical. But since many European countries established a monetary union at the end of the century, the theory of monetary unions has become much more relevant to many more people….

●      European Union, from the Concise Encyclopedia of Economics

●      The European Union (EU) includes twenty-seven countries and 490 million people. In 2005, the EU had a $13 trillion (€11 trillion) economy, a single market, and for some member countries, a single currency. A growing number of political and economic decisions are made on a pan-European level in Brussels….

●      Capital Flight, from the Concise Encyclopedia of Economics

●      There is no widely accepted definition of capital flight. The classic use of the term is to describe widespread currency speculation, especially when it leads to cross-border movements of private funds that are large enough to affect national financial markets. The distinction between “flight” and normal capital outflows is thus a matter of degree, much like the difference between a “bank run” and normal withdrawals. The most common cause of capital flight is an anticipated devaluation of the home currency. No one wants to be caught holding assets that lose 20 or 30 percent of their value overnight, so everyone tries to buy gold or foreign currency….

●      Nothing New on the Euro Front, by Wolfgang Kasper.

●      Most people around the world–laymen and seasoned investors alike–seem confused and bemused by the unfolding saga of the troubled Euro. Though I’m a distant observer of the Euro experiment, nothing has surprised me so far. …

●      Cowen on the European Crisis. EconTalk podcast.

●      Tyler Cowen of George Mason University talks with EconTalk host Russ Roberts about the European crisis. Cowen argues that Greece is likely to default either in fact or in spirit but that the key question is which nations might follow–whether Italy and Spain can find a road to economic health and honoring past debts. Cowen gives his best guess as to what is likely to happen to the euro and the European Union and the implications for the rest of the world. He explores some less likely scenarios as well. He is pessimistic about Greece and the short-run prospects for preserving the status quo, but he is optimistic in the long-run about the European Union though it may have a different structure down the road….

A Little History: Primary Sources and References

●      Gold Standard, from the Concise Encyclopedia of Economics

●      The gold standard was a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold. National money and other forms of money (bank deposits and notes) were freely converted into gold at the fixed price. England adopted a de facto gold standard in 1717 after the master of the mint, Sir Isaac Newton, overvalued the silver guinea and formally adopted the gold standard in 1819. The United States, though formally on a bimetallic (gold and silver) standard, switched to gold de facto in 1834 and de jure in 1900….

●      William Jennings Bryan’s “Cross of Gold” Speech: Mesmerizing the Masses, at History Matters. Transcript and audio.

●      The most famous speech in American political history was delivered by William Jennings Bryan on July 9, 1896, at the Democratic National Convention in Chicago. The issue was whether to endorse the free coinage of silver at a ratio of silver to gold of 16 to 1….

●      “You shall not crucify mankind upon a cross of gold.”

Advanced Resources

●      Robert Mundell, a biography from the Concise Encyclopedia of Economics

●      Robert Mundell was awarded the 1999 Nobel Prize in economics “for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas.”…

●      Studies in the Theory of International Trade, by Jacob Viner on Econlib

●      Economic history of international trade with a focus on mercantilism, the gold and silver bullion standards, and comparative advantage.

●      The History of Bimetallism in the United States, by J. Laurence Laughlin on Econlib

●      Economic history of the gold and silver standards at the end of the 19th century.

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