2024 Author: Howard Calhoun | [email protected]. Last modified: 2024-01-07 20:55
The exchange rate is constantly in a state of fluctuation, therefore, in order to avoid risks of a financial and economic nature, it is necessary to understand the forecasting mechanism and the mechanism that explains how the exchange rate is formed.
This issue is especially relevant today, when Russia seeks to get out of dollar dependence by pursuing an independent policy. To understand some of the difficulties that arise along this thorny path, it is necessary to understand how the exchange rate is formed in Russia and around the world.
A bit of history
Until the thirties of the last century, the so-called gold standard operated in most countries. According to him, the gold content was established in the currency. Governments were required to exchange their currencies for gold. To support the system, a strict correlation was introduced between the money supply within the country and its gold reserves. According to the gold content, their courses were formed. For example, one US dollar had twenty-three and twenty-two hundredths of a grain of gold, and oneEnglish pound - one hundred and thirteen grains, that is, four point eighty-seven hundredths of times more. According to these calculations, the exchange rate was determined, where one pound was equal to 4.87 dollars.
Gold currency system
After the 1930s and the Great Depression in America, most countries established a gold exchange system, where exchange rates were already formed at the expense of the reserve currency, which was the dollar. The International Monetary Fund established in 1944 contributed to maintaining exchange rates in stability. Due to contributions from there, loans were allocated to states experiencing financial difficulties.
Floating exchange rate system
How is the exchange rate formed? In the 1970s, the gold exchange system was replaced by a system of floating exchange rates. Its meaning lies in the formation of exchange rates due to the relationship of supply and demand, like securities on the stock exchange. However, the exchange rate did not become completely free. When a certain limit was reached, the state had parity (as since 1979 in Europe), and the Central Bank of the country, coordinating its actions with other countries, officially changed the course. If the change was downward, then there was a revaluation, and an increase - devaluation. The limit was reached with changes of a few percent, but in the nineties it increased to fifteen percent.
Revaluation and devaluation are not the only ways in which the state intervenes in the process of explaining how the exchange rate is formed. To avoid strong fluctuationsthey introduce so-called foreign exchange interventions, where, if the exchange rate falls, they buy it, and if vice versa, they sell it.
The mechanism is not always successful, as the owners of the national currency, located abroad, do not obey the instructions of their governments. For example, if the US raises the rate on a loan, then the lending rate of currencies outside the US remains the same, which makes them more attractive.
General factors affecting the formation of the exchange rate
How the exchange rate is formed on the stock exchange, in banks and in states in general.
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Export and import. The higher the prices in comparison with foreign ones in the country, the greater will be the import. Therefore, the price of foreign exchange will be high.
As income rises, the demand for imports will increase, causing the national currency to depreciate.
On the other hand, with a high national income abroad, the price of foreign exchange decreases.
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Movement of capital. If an investor wants to receive more foreign cash, deposits, stocks, bonds and liabilities, the price of foreign currency increases.
On the other hand, payments to a government strengthen its currency.
- Data output and waiting for data output. Such data include: publication of economic indicators by host countries, statements on changes in interest rates, economic reviews and more.
- Activities of funds. great strength,affecting the movement of exchange rates, funds borrow when they are invested in certain currencies. They have great means to make the course move in any direction.
- Activity of exporters and importers. They are users of the foreign exchange market who are interested in buying and selling foreign currencies. However, this impact is insignificant and short-term, because the volume of their foreign trade transactions is negligible compared to the total volume of transactions in the foreign exchange market.
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Statements of politicians. At various meetings, summits, press conferences and so on, such speeches are closely monitored online, after which the foreign exchange market immediately reacts depending on the strength of the statements.
Everyone remembers the end of 2014, when Russian President V. V. Putin instantly stabilized the ruble exchange rate (“the exchange rate spoke”) with one of his speeches, thus stopping its rapid decline.
- Activity of central banks. The mechanism of its influence is described below.
Central Bank
Let's consider how the exchange rate of the Central Bank is formed.
The influence of states on the foreign exchange market is carried out through central banks. As already noted, it is extremely rare that the state does not intervene at all in currency exchange operations (a state of free floating). As a rule, they affect the course (dirty floating condition) from time to time, thus affecting howthe exchange rate of the Central Bank is formed.
In the interests of production and consumption, the state carries out direct and indirect regulation. Direct regulation takes place in the discount policy and foreign exchange interventions. Indirect regulation is carried out through the inflation rate, the amount of money in circulation and more.
CBR
More on how the exchange rate of the Central Bank of the Russian Federation is formed.
Every day, except for weekends, the Central Bank of the Russian Federation sets the rates for most currencies against the ruble. The dollar against the ruble is determined on the basis of how the auction went the day before on the Moscow Interbank Currency Exchange. The same applies to the euro. The remaining currencies are formed through cross-rates, that is, the ratio between the ruble and another currency, based on the ratio to the dollar.
The way the exchange rate of the Central Bank of the Russian Federation is formed is also influenced by imports and exports. If more goods are sold than bought, it will be better for the national currency to fall in price, and vice versa.
The Central Bank sets the rate for more than thirty kinds of currencies. This is the dollar, euro, yuan, franc, yen, hryvnia and others.
Since 2005, the Central Bank of the Russian Federation switched to the dollar-euro bi-currency basket. It is believed that in this way a more flexible regulation is achieved and an increase in volatility is realized. The rate is calculated from the ratio of the dollar-euro currency pair on the Forex markets and the ruble quotes against the euro on the MICEX.
Banks
How the exchange rate is formedin banks? Other banks are free to set their own rates. They basically offer to buy the currency at a lower cost and sell it at a higher price than the price offered by the Central Bank.
MICEX
How the exchange rate is formed on the MICEX is also an interesting question.
Foreign currency trading on the Moscow Interbank Currency Exchange is regulated by the Central Bank of the Russian Federation, which performs its functions on the basis of the federal law on public procurement, the federal law on currency regulation and control.
Forex
It is difficult for an ignorant person to understand how the exchange rate is formed on Forex.
In the international Forex market, the price is determined by the struggle of buyers (or bulls) and sellers (or bears). Individuals are unable to influence the situation in this market. Only the International Monetary Fund and central banks can influence price movements, and then only in the short term.
The patterns explaining how the exchange rate is formed here are as follows:
- When the demand for a currency increases, its price also increases, and when the demand decreases, the price decreases accordingly.
- When the supply of a currency increases, its value falls, and when the supply decreases, the price, on the contrary, increases.
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