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What causes the foreign exchange market?

What causes the foreign exchange market? The main source of foreign exchange transactions is the occurrence of international economic and trade and the subsequent needs for international settlement, international investment, foreign exchange financing and foreign exchange preservation. In international economic activities, because the currencies and monetary systems of various countries are independent of each other, the currency of one country cannot circulate in another country. In this way, in international economic activities, foreign claims, debt settlement and international investment, people need to exchange foreign currency into domestic currency, or exchange domestic currency into foreign currency, and foreign exchange transactions have become inevitable and necessary. In the actual economic operation, the deeper root of foreign exchange trading lies in the motivation of currency substitution and asset substitution. When assets are denominated in foreign exchange and used as a means of payment, currency substitution occurs; when assets are denominated in foreign exchange and used as a store of value, asset substitution occurs. Some people need foreign exchange to purchase foreign goods, some people need foreign exchange to invest and build factories overseas, some people need foreign exchange to maintain value, some people need foreign exchange to borrow and repay foreign exchange principal and interest, and some people need foreign exchange to speculate. In short, according to different motivations, foreign exchange transactions for different purposes are produced. (1) Foreign exchange transactions for trade settlement Foreign trade requires foreign exchange transactions. This is the original motivation and the earliest type of foreign exchange transactions. According to statistics, in modern trade settlement, the proportion of the US dollar as the international settlement currency is as high as 40%, and other currencies such as the euro, the yen, and the pound also occupy a considerable proportion. Generally speaking, after the trading partner pays the payment, the exporter will convert it into local currency or other foreign currencies, thus creating the need for foreign exchange transactions; when importers import goods from abroad, they usually have to convert their domestic currency (or the non-settlement currency they hold) into foreign currency) into the foreign exchange required for settlement, thus generating foreign exchange transactions. (2) Overseas investment and foreign exchange transactions There are many forms of overseas investment, such as investing in Hong Kong stocks in China, opening a restaurant in Canada, setting up a factory in the UK, buying a house in the United States, opening a store in Poland, etc. , all need to exchange their own currency or the currency (foreign exchange) of other countries into the currency of the country where the investment is located, thus forming foreign exchange transactions for foreign investment. There are two main ways of international investment: direct investment and indirect investment. Direct investment refers to direct investment by enterprises and individuals from one country in another country, which can be carried out by establishing new enterprises, acquiring equity interests in foreign enterprises, and reinvesting profits. Indirect investment, also known as portfolio investment, is achieved by purchasing medium- and long-term bonds in the international bond market or stocks of foreign companies in the international stock market. No matter how you conduct international investment, you must convert your domestic currency or foreign currency (foreign exchange) into the currency of the country (or region) where the investment is made. For example, in the mid-1980s, the United States changed from the largest creditor country to the largest debtor country in the world. The "Japan Buys America Movement" made Japan the largest investor in the United States, and about 70% of the treasury bonds issued by the United States were purchased by the Japanese. Japan has also invested heavily in real estate and other industries in the United States, purchasing American companies and stocks. These investments require the conversion of Japanese yen into U.S. dollars, and the U.S. dollar earnings also need to be converted back into Japanese yen, all of which are achieved by participating in foreign exchange transactions in the international market. Beginning in the mid-1990s, with the bursting of the Japanese bubble economy, the Japanese economy declined, the U.S. economy recovered, and the "American Buy Japan Movement" emerged. American investors need to convert U.S. dollars into Japanese yen for investment, and the Japanese yen they receive also need to be converted into U.S. dollars and sent back home. (3) Foreign exchange transactions for the purpose of maintaining foreign exchange value. From the end of World War I to 1973, during the Bretton Woods System era, all currencies of various countries adopted a fixed exchange rate system. Although there have been several fluctuations during this period, the demand for foreign exchange hedging is not obvious. With the collapse of the Bretton Woods system, the fixed exchange rate system was replaced by a floating exchange rate system, and changes in exchange rates were entirely determined by market supply and demand. The exchange rates between currencies of various countries rise and fall from time to time, and sometimes the daily change rate can reach 5% ~ 10%. Under a floating exchange rate system, currency appreciation will bring benefits to currency holders, while currency depreciation will bring losses to currency holders. In order to maintain the value of foreign exchange, banks (including central banks), large companies and even ordinary residents around the world participate in foreign exchange transactions to varying degrees. Each major enterprise, group, and company has its own foreign exchange management department, and one of its businesses is to conduct foreign exchange transactions to achieve the purpose of maintaining value. Our country's national foreign exchange reserves are managed by the Reserve Department of the State Administration of Foreign Exchange, with hundreds of millions of dollars of foreign exchange transactions every day, in order to adjust the proportion of various currencies in our country's foreign exchange reserves and achieve the purpose of maintaining value. If foreign exchange hedging transactions (selling currencies with falling exchange rates and buying currencies with rising exchange rates) are done well, you can not only preserve value, but also make profits and achieve foreign exchange appreciation. For example, from the beginning of 1989 to April 1990, U.S. dollar interest rates were high, and the U.S. dollar exchange rate also showed an upward trend, with an increase of 296%. If the investor bought 10 million US dollars of Japanese yen at that time, he would receive an exchange difference of 2.96 million US dollars. Since the interest rate of the US dollar is 29% higher than that of the Japanese yen, the interest rate difference income can reach 290,000 US dollars. The total income of the two items Up to $3.25 million. (4) Foreign exchange transactions resulting from foreign exchange financing, borrowing and loan repayment With the comprehensive development of my country's reform and opening up, the amount of foreign investment introduced has increased significantly in recent years, and the scale of foreign debt has also shown an upward trend, resulting in a large number of foreign exchange transactions. Since the foreign exchange borrowed is different from the currency used to pay for imports, there is a problem of currency conversion, resulting in the need for foreign exchange transactions.

For example, borrow yen and pounds from the bank, issue yen bonds in Japan, and issue pound bonds in London, and get yen and pounds respectively; but if the import payment requires dollars or euros, you need to conduct foreign exchange transactions to convert the borrowed currency into Pay in the required currency. This is a foreign exchange transaction brought about by the use of funds after borrowing. When the loan matures, the enterprise should repay the principal and interest on time. If the debtor does not have enough borrowed money to repay the loan and needs to repay the loan in other convertible currencies, foreign exchange transactions must be conducted to convert other types of currencies into the specified repayment currency. There is an issue of exchange rate risk here. Borrowers may suffer losses due to large changes in exchange rates. For example, in China's foreign debt structure, the Japanese yen accounts for a large proportion, and drastic changes in the Japanese yen exchange rate will undoubtedly impose a great burden on us. If an enterprise borrows a Japanese yen loan worth US$10 million in March 1998, the exchange rate at that time is 1 US dollar to 130 yen, and it matures in March 2008. However, in March 2008, the US dollar to Japanese yen The exchange rate has dropped to 1 US dollar to 100 yen. According to the exchange rate at this time, the loss suffered by the company has reached 3 million US dollars, not counting the interest burden. If the corresponding hedging business had been carried out, the losses would have been controlled within a very small range, otherwise the losses would have been unbearable for the company. Therefore, when companies borrow foreign capital, they must not only consider the interest rate differences of different currencies, but also consider possible changes in the exchange rate. It can be seen that foreign exchange transactions are essential whether it is international repayment or financing. (5) Foreign exchange transactions required for financial speculation. Speculative foreign exchange trading is generally not based on real commodity transactions or capital movements. They only hope to make profits from changes in exchange rates and make profitable trades by buying low and selling high. This type of transaction plays an increasingly important role in Forex trading. Speculators buy and sell frequently in the foreign exchange market, adding fuel to the fire and making the changes in the foreign exchange market even more mysterious. There are banks, companies, and individuals in every corner of the world engaged in currency speculation. In China, currency speculation began to rise, and some financial institutions were allowed to conduct foreign exchange transactions on their own or on behalf of clients, becoming new targets pursued by speculators. Foreign exchange is widely used as a tool for financial speculation, resulting in many financial derivatives, such as futures trading and options trading.