Exchange Rate Information

What Is an Exchange Rate Regime?

The exchange rate between two currencies may be determined in international foreign exchange markets or in a government office. If an exchange rate — say, the yen–dollar rate — is determined in international foreign exchange markets based on the demand for and supply of the yen, then the markets determine the exchange rate.

This situation is similar to the case of any other good, such as oranges, whose price is determined in the market based on the demand for and supply of oranges. If the exchange rate is mainly determined in international foreign exchange markets, it’s called a floating exchange rate regime.

Exchange rates involving developed countries’ currencies, such as the U.S. dollar, the euro, the pound, the yen, and the Swiss franc, are determined in foreign exchange markets — mostly. When referring to these currencies, you may hear the term dirty float because of occasional central bank interventions in foreign exchange markets.

If floating or dirty floating currencies are at one extreme of the foreign exchange regime spectrum, pegged exchange rate regimes are toward the other end of the spectrum. In a pegged exchange rate regime, governments either don’t allow their currency to be traded in international foreign exchange markets or impose restrictions on trade.

In fact, governments determine the exchange rate unilaterally and announce it to the world. Although a variety of pegged exchange rate regimes exist, you can think about pegged regimes in which the government determines the exchange rate. Governments have reasons to keep the exchange rate involving the domestic currency at a certain level.

Don’t think of pegging the exchange rate as an easy decision. As any other decision, the decision to peg implies tradeoffs. Governments that decide to peg their currency have to decide whether they want to allow foreign portfolio investment in and out of the country.

If governments allow foreign portfolio investment, this approach attracts foreign investors into the country and opens new sources of financing for the country. But it can also spark a currency crisis, as foreign investors cash out their investment in the fear of depreciation, leaving the country in desperate need of foreign currency.

Alternatively, a government may decide to peg the exchange rate without allowing foreign portfolio flows. This approach may prevent a currency crisis, but it also makes an additional financing opportunity unavailable.

Does the Type of Money Matter for the Exchange Rate?

A close relationship exists between the type of money and the exchange rate regime. A monetary system based on a metallic standard such as the gold standard leads to a fixed exchange rate regime. For a good part in human history, some kind of a metallic standard governed.

However, don’t assume that the reign of the metallic standard was continuous throughout history. Mostly because a metallic standard such as the gold standard doesn’t allow monetary policy, countries left the metallic standard whenever they had to endure a war or a military conflict so that they could print money and finance the war effort.

Money that’s not backed by a precious metal has no intrinsic value. It’s called fiat money. Therefore, the type of money used during the gold- (and/or silver-) standard periods interrupted by wars or revolutions was fiat money. This type of money has been used from 1971 through today.

A metallic standard, such as the gold standard, leads to fixed exchange rates. What kind of exchange rates would we have when currencies are fiat? The answer is that fiat money doesn’t imply a certain kind of exchange rate regime.

It’s up to countries to decide what kind of an exchange rate regime they want to have. In fact, following the end of the metallic era in 1973, developed and developing countries decided differently about this matter. While all developed countries adopted a floating exchange rate regime, most developing countries adopted some kind of pegged exchange rate regime.

In a pegged exchange rate regime, governments announce the exchange rates between the domestic currency and other major currencies. Pegging is done for a variety of reasons. First, pegging can support the country’s development strategy. For example, if a country wants to industrialize and needs to import a variety of intermediate goods, it can make its imports cheaper by overvaluing its currency.

On the other hand, if a country wants to promote its export sector as the engine of growth, undervaluation of the currency can accomplish this goal. In addition, a pegged currency can function as a nominal anchor to signal economic stability.

In particular, developing countries used the pegged regime to attract foreign investors. In this case, the investment in question is portfolio investment and implies investing other countries’ equity and debt securities.

Unilaterally pegged exchange rates in developing countries, especially in emerging markets with a potential to grow, sounded like an ingenious plan. These countries needed hard currency in large amounts, and international investors wanted to have higher nominal returns with virtually no exchange rate risk.

But this kind of hot money comes in fast and leaves fast. When investors became anxious that these countries couldn’t continue with the peg, they cashed in their portfolio in return for hard currency, leaving the countries in a currency crisis.

When talking about exchange rate regimes and currency crises, the International Monetary Fund (IMF) has to be included in the discussion. The IMF was introduced during the Bretton Woods conference in 1944 as the coordinator of the post–World War II international monetary system.

The post–World War II system was a variation of the metallic standard and was called the reserve currency system. The dollar was pegged to gold, and all other currencies were pegged to the dollar.

As in the case of any metallic standard, an agency such as the IMF needed to keep an eye on current account imbalances and redistribute funds from countries with a current account surplus to countries with a current account deficit. As early as the late 1940s, it became clear that the IMF didn’t have enough funds to fulfill its objective.

Following the end of the Bretton Woods era in 1973, the IMF remained in business even though there was no metallic standard and therefore fixed exchange rates. However, as developed countries adopted floating exchange rates, most developing countries believed that if they adopted a floating exchange rate regime, their countries’ fiscal and monetary problems would depreciate their currency too much.

Therefore, after 1973, most developing countries unilaterally pegged their currency to the currencies of major developed countries. But pegged currencies experience crisis, meaning that countries lose their international reserves when fiscal and monetary policies aren’t consistent with the peg.

Therefore, the IMF remained in business, this time to provide balance of payments support to developing countries. Over the decades, the IMF has been criticized for providing financial support to countries that implement macroeconomic policies inconsistent with their currency peg.

The Roles of Speculators and Central Banks in Foreign Exchange Markets

Speculators and central banks are important participants in foreign exchange markets. Speculators invest in assets denominated in different currencies and, therefore, buy or sell currencies. Central banks may be engaged in foreign exchange markets to increase or decrease the value of their currency with respect to other currencies.

Speculators in foreign exchange markets

The generic term speculator includes a wide variety of market participants. Foreign exchange traders and brokers make up a relatively small segment among speculators; commercial banks, hedge funds, and other financial companies represent the most important group among speculators.

Regardless of type, speculators in foreign exchange markets want to profit from buying currency low and selling it high. In other words, all speculators try to make a profit from fluctuations in exchange rates.

The interbank market, which consists of large commercial banks and financial firms, is a major player in foreign exchange markets. Its activity helps determine the bid (buy) and ask (sell) price of currencies. This market has no trading floor, but banks can trade with each other directly or via electronic brokerage systems that connect market participants.

Multinational companies also engage in speculation because they make or receive payments denominated in various currencies to and from firms around the world. These currencies fluctuate on a daily basis. Therefore, multinational companies are also involved in speculation to hedge against their exchange rate risk.

Central banks in foreign exchange markets

Central banks have a unique place in foreign exchange markets. First, unlike the other groups involved in foreign exchange markets, the central banks’ involvement in foreign exchange markets doesn’t have a profit motive.

Second, central banks’ decisions regarding monetary policy are extremely influential on exchange rate determination. Central banks indirectly affect exchange rates through their monetary policy decisions. In every country, central banks are responsible for conducting monetary policy, among their other roles. The main goals of monetary policy are to promote price stability and economic growth.

Basically, a central bank addresses the domestic economy’s problems by changing the quantity of money and interest rates, which leads to changes in the exchange rate as well.

Third, central banks can directly affect exchange rates through interventions into foreign exchange markets. A central bank can use its domestic currency and foreign currency reserves to buy or sell foreign currencies directly in the foreign exchange market.

Alternatively, central banks may be involved in foreign exchange markets for reasons that aren’t related to their own countries but are related to the common concerns at the international level. For example, several central banks may come together in a joint action in foreign exchange markets to provide liquidity and credit across the world.



Iraqi Bank: foreign currency market decreased from 150 to 50 million dollars a day

29/04/2011 19:31

Baghdad, April 28 (AKnews) - The adviser of the Iraqi Central Bank (ICB) said Thursday that selling the hard currency decreased from 150 million $ to 50 million $ per day because of the problems that face the clients in the private and government banks related to the tax disclosure.
 DollarsMuzher Mouhammed told AKnews that the clear decline in the proportion of buying the hard currency goes back to the governmental strictures on the tax disclosure and it is an obstacle facing clients in the private and state bank.
"The central bank seeks to coordinate between the monetary policy and fiscal policy through the provision of tax disclosure requirements at the government tax departments," noting that "it is a procedure done by most of the international banks to balance the economic value and achieve the banking development."
"This sudden drop will certainly affect the purchasing power of Iraq for foreign currency, but it will not last long because of the politicy adopted by the ICB in the promotion of the foreign currency market and increase the Iraqi dinar exchange rate."

The ICB allocated 250 billion Iraqi dinars as a minimum for the establishment of private banks in the country.

The parliament legislated at its first session the Banking Law in 2007 to organize the work of private and state banks.
The ICB revealed on February that he will give a number of licenses to establish private banks, stressing on that the banks will increase the role of the country's economy.
The total capital of Iraqi private banks is estimated by one billion and 600 million dollars now, other than what the branches of Arab and foreign banks operating in the country have.

The main task of the ICB is to maintain the prices stability and the implementation of monetary policy, including exchange rate policies, managing the reserves of foreign currency, issuance and management of currency as well as regulating the banking sector.
Reported by Jaafar al-Wannan
RN\GS AKnews

This is a good story and factual too... this having to do with exchanging foreign currency in the USA. This is the link but you have to be registered and sign in to see it I think.

The other thing this story brings to the surface is that if it's true that the Federal Reserve is the middle man for the IQD exchange, then they have another barginning chip in their favor if they have made any oil for IQD deals with Iraq.

Ok Friends, Here ya go...
I listen to Tony Breitlings audios regularly, as I like his logical train of thought,
So, I learned that asking the right questions will get you the right answers....
and that regularly he states that when he cashes in, he's just going to go to BofA,
and that regularly everyone says it so much cheaper to go to ALI or other places,
that only charge a FLAT RATE for the exchange(Ali says $150 per Million IQD),
instead of going directly to a local bank of my choice... everyone has heard this...

Well Now here is my story...
I have avoided getting involved in Rumors or BANK STORIES, on purpose,
cause I hold my cards close to the chest in games like this...
So today the Bank of America is open from 9am to 2pm on Saturdays,
and I go in to cash a check, and use my debt card to avoid monthly account charges!

So my friend is the Bank Manager in this branch, not a teller, not a greeter, THE MANAGER...
and I'm thinking to myself, How can i get some good currency Info(Reliable Info), and not tip my hand to them,
so i start the conversation asking about random currency exchange questions and policies,
knowing that I do not want to explicitly ask about the IQD, i ask about currency exchanges in general...
Questions like these...
"What does the bank charge for a percentage on currency exchanges?", "How do they get rate updates?",
"Who designates the rate of exchange?" and "How does the exchange occur...CASH?...ACCOUNT DEPOSIT?, HOW?"

So here is what she answered me to the questions I asked...

"What does the bank charge for a percentage on currency exchanges?"
"She Said: that the bank does not charge a percentage to exchange currency, it is an even exchange for the rate!"

"How do they get the rate or updates on the rate?"
"She Said: Every Morning they get an update from the TREASURY!"

"Who designates the rate of exchange?"
"She Said the FED is the one that designates the RATE and it is updated daily, every morning!"

"She Said: The exchange is made at the teller window, They have a big book listing all acceptible currencies,
and unless it is done by a drop deposit transaction in the drop box, or by a private banker,
which then the transaction is done privately in a confidentially stall, for the customers benefit,
and that usually for larger transactions an appointment would be nice to schedule ahead of time,
but the appointment is not needed if the customer would like to wait for their turn, in the banks waiting area!"

SO, being myself, an inquiring mind... I went on to ask more questions,
I still did not mention the IQD, as I did not want her to clam up and feel uncomfortable ..

So I asked:
"How does the bank make money on the transaction if they make no percentage on the transaction?"
"She told me that the rate comes directly from the FED and they payout that specified rate, but that the rate they pay,
does not mean that, the rate paid to customers is the same rate the FED pays the BANK for redemption of the currency!"

We also talked about the spread between the BUY and SELL Prices, and "How to BUY CURRENCY the buyer pays the SELL RATE,
and to SELL CURRENCY the seller pays the BUY RATE, and How confusing this process was to the average customer...

Seeing my chance to clarify this further I made an analogy to her...
I said:
"So it is kinda like Pop Bottles, the deposit rate that i receive from the bottle,
is like the FED rate that banks pay directly to their customers for the transaction,
and as such, the store who redeems the Pop Bottles is not doing this for free,
they have employee labor involved and temporary storage, as well as liability while in storage,
and so, the Distributor or Bottler whom buys the Pop Bottles back from the store,
Provides them a greater rate than the pay-out transaction rate, that the customer receives from the store!"
She Said: YES, Exactly, that she had never thought of it like that, as she never considered the comparison,
but that this analogy I provided her was an excellent example of the process, that the BANK experiences!"

SO, the moral of the story is:
That the FED can set whatever rate they want to redeem foreign currency, and that the IMF sets guidelines to the rate,
but that does not mean that the FED has to offer that rate, they could offer more or less, just like currency traders do,
and just because standardized rates are stated by the FOREX or IMF or CENTRAL BANK, the FED can specify any rate it wants,
and if you do not like the rate of exchange, you can exchange the currency to another exchange source, on the open market!

Understandably, like any other thing in life, the value of anything is what it is worth to whom wants it...
and the fact is, that BANKS can not exchange your money and then take it to a foreign country to trade it in,
THEY MUST use the FED as the Middle Man for the transaction to get their money back, Simple as that...
and the bank does make a profit on the transaction, outside of the stated rate of exchange when they redeem it to the FED...

PLEASE UNDERSTAND, this is only BANK of AMERICA practices, or so I was directly told by the BANK MANAGER,
other banks could and probably do have other practices internally, and other policies specific to that bank!

BUT when the time comes,
"Do Not Be Afraid to go to your bank and ask what the percentage is on the foreign currency transaction?"