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Q about forex

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slindo Posted: Thu, Mar 27 2008 3:30 PM
I am a novice when it comes to financial markets so pardon me if this is a silly question. Why do foreign currencies change value daily? Does this reflect the actual buying power of the currency or the perceived buying power of the currency? Is the currency market a futures market in disguise? To what extent does perception influence reality?
Stephen Lindo
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Solredime replied on Thu, Mar 27 2008 3:50 PM

To what extent does perception influence reality?

To the extent that if I imagine a table in front of me, it shall appear! Mwahahaha....sorry I just thought i'd purposefully mis-interpret that comment as something to do with solipsism.

As to your actual question, I hope you're not asking anyone to put a number on these psychological factors, as that would be impossible, or at least any numbers that you could conjur would be terribly inaccurate.

So in more subjective terms, I'd say that all speculative markets are dependent upon both reality and the future perception of reality. Even the inflation rate is dependent on the future inflation rate. Of course, like with any other commodity, speculators will speculate as to the future value of the currency, but this does not make this a futures market. Of course, underlying all of these expectations are the true purchasing powers of the different currencies, and I guess that they are still a main guiding force for the markets. They will change daily because every day new reports come out. As an example, perhaps consumer confidence rose, and so speculators might predict that they will borrow more money into existence, causing inflation.

In reality I'm not actually sure, so I'd wait for someone else to answer. 

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jimmy replied on Thu, Mar 27 2008 5:53 PM

Forex is bought and sold like any commodity. There are people willing to sell for x and people willing to buy for y. When the two meet you have a deal. Why would people buy a foreign currency? Well, for example, imagine I own a winery in Australia and I persuade a distributor in the US to buy 50,000 cases of my wine - we haggle a bit about what he's willing to pay and what I'm willing to sell for and eventually settle on a price. However, delivery will be made once the wine is actually read (say in 9 months time). As such, as an exporter I have an exchange rate risk if I sign a contract that specifies he'll be purchasing the wine for US$x... so I might buy, on the day we signed the contract, exactly US$x to hedge myself against the risk that the US dollar weakens between now and when he buys the wine. When i buy US dollars of course I'm bidding on an open market with a bunch of other people for a limited number of dollars that other folks want to sell. If more people want to buy than want to sell then the price of those dollars is going to go up until such a time as the number of buyers equals the number of sellers (that's kind of badly worded - it should read until the number of dollars being bought equals the number of dollars being sold).

On the other hand, if I wanted to import goods from Indonesia I might have to pay in Indonesian baht. In order to by the goods then I'd have to buy sufficient baht to pay for those goods. So imports and exports can have a fairly strong influence on the strength or weakness of a particular currency.

Additionally, if a central bank (such as Sweden) decides to reduce it's reserve holdings of, say, US dollars (as they did last year) then they need to find a buyer... That's going to mean lots more US dollars for sale and will likely drive the price of dollars down (more supply but no additional demand). So the decisions of central banks around the world to hold one currency or another in reserves can affect exchange rates quite considerably. Generally those decisions are made with respect to macroeconomic considerations (the risk that a particular country might be inclined to print it's cash a little too quickly, like Zimbabwe, would probably prompt central banks around the world to try to get rid of any reserves it had of that currency - since getting something for these is better than seeing them whittled down to nothing by the reckless central bank that controls that particular currency).

I'm sure there are all sorts of other things that would cause forex prices to go up and/or down as well, but those are a couple of the main ones.

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