Learn Forex Trading for Beginners

Beginner
Trading101
20 Lessons
20 Hours

Money and Its Valuation: A Journey into the Past

The notion of money appeared a long time ago. Earning and spending money has followed in every step of the way since ancient times to current days.

Moreover, money connects people.

Money has the power to change everything: politics, governments, people…it has a saying in all the aspects of life. Like it or not, it is the desire to have more money that drives most people.

But how did money appear? How was the notion of money born?

It all started with bartering. Or, with changing goods people needed with goods they had in excess.

Hence something valuable emerged. Before metal coins appeared, the notion of money took various shapes. Hundreds of objects were considered money.

But above all, money shows trust. People pay for goods and services with money and the other party trusts the money will be able to be used in other transactions.

It was like this since the beginning, and it remained the same to this day.

The Financial System as We Know It

The Bretton Woods conference in 1944 set the pillars of the current financial system. With Europe ravaged by war destructions, no other country objected to the U.S. Dollar being at the heart of it.

However, the number of dollars in the economy was supposed to be backed by gold. In other words, if the Federal Reserve of the United States wanted to issue more money, it needed to back the quantity with fresh gold reserves.

Hence, trust was an issue. It lasted some time, but eventually, the United States gave up and the gold standard dissolved.

The so-called Nixon shock in 1971 canceled the U.S. Dollar’s convertibility to gold. In plain English, the dollar became a simple piece of paper.

And, people were supposed to believe it has the same value because it was backed by the United States central bank (the Fed).

That was the start for other nations to drop the gold peg. Some countries, like Switzerland, still kept a certain percentage of the money issued to be backed by gold until the start of 2000’s. Not anymore.

Today, the currencies reflect the value of each economy. On the Forex market, they are paired together, with the U.S. Dollar as the cornerstone of it.

In Forex trading, everything relates to the dollar. First, it is the world’s reserve currency.

Namely, foreign countries keep the most significant part of their excess reserves in American dollars.

Second, commodities (e.g., oil) are denominated mostly in U.S. Dollars.

Finally, it is the currency of the world’s largest economy. Therefore, what happens with the dollar moves the Forex market.

Central Banks in Forex Trading

Central banks play a significant role in Forex trading. In earnest, they set the interest rate level for each currency that exists on the Forex dashboard.

As a rule of thumb, the higher the interest rate is, the more attractive the currency is to potential buyers. After all, everyone wants to own a currency that pays a higher interest rate.

It is like having a pile of cash and looking for a commercial bank to park your money in. You’ll end up choosing the bank that offers the higher interest rate on your deposit.

The same with currencies. The higher interest rate attracts more buyers.

Hence, everything in Forex trading, absolutely everything, depends on the level of the interest rate for each currency.

During the trading month, all kind of economic data comes out in various parts of the world: GDP (Gross Domestic Product), CPI (Consumer Price Index), jobs data, inflation data, and so on. Forex traders watch the data with considerable attention, for a single reason: they look if the data might influence the central bank and its monetary policy (e.g., interest rate level).

For example, if inflation ticks up, the chances are that the central bank will hike the rates, or at least will use a hawkish (a.k.a. will talk the currency up) tone on the next meeting. However, until the next meeting, there’s plenty of time left so that traders will jump on the trade straight away.

While in ancient times the value of money was given by the goods and services it bought, today…it is the same. Money and its valuation remain the same, only the players differ.

When money was silver or gold coins, rulers diluted or increased the precious metal’s percentage in coins. What that did, was the equivalent of monetary policy these days. Or, the equivalent of hiking or cutting the interest rate.

Most Important Currencies in the World

We’ll discuss some other time the Forex dashboard and its structure, but the most influential currencies in the world are worth mentioning. You’ll be surprised to hear the outcome.

It all starts with the world’s reserve currency: the U.S. Dollar. The United States is the world’s largest economy, and the current financial system is built on the dollar as its pillar.

Euro comes next. The European Union appeared for a single reason: to create a market big enough to compete with world’s powerhouses (e.g., United States, Japan, China, Russia).

And so, uniting over twenty different nations, the European Union had more power to negotiate on the macroeconomic level. On top of it, nineteen countries share the same currency: The Euro.

Combined, the economies of these countries make the second largest economy after the United States.

For this reason, the EURUSD pair is the central pair in Forex trading. It has the most significant liquidity, the lowest spread, and all brokers offer the best conditions for it.

Moreover, the two central banks, the Federal Reserve of the United States and the European Central Bank (ECB), have a dominant influence and act like leaders for other jurisdictions. For example, if the ECB cuts rate, most likely the Swiss National Bank will do that too.

Add to the two the other major economies and their currencies (Australia, Japan, Canada, United Kingdom, etc.), and you’ll have a clear picture of what Forex trading and Forex dashboard means.

Interesting enough, China, one of the largest economies in the world, keeps the Chinese Yuan under its close supervision. For how long though?

Conclusion

Money plays a pivotal role in any society. Its valuation, also.

The amount is not everything. One can have piles of money, and still the value to be close to zero. Just look at what happens in Venezuela, with inflation diluting the paper money’s worth at astonishing rates.

The two, money and valuation, should go hand in hand. For this reason, central banks appeared.

Controlling the amount of money on the market means controlling its valuation. Moreover, issuing of new money is subject to rules and regulation beyond the control of governments.

Or, at least, this is how it should be. Major democracies proud themselves with the independence of their central banks.

In fact, it is written in the foundation of each capitalistic economy that the central bank is independent. It means the government (governments, in the case of the ECB) won’t intervene in its decisions, no matter what.

It's not always easy to set the monetary policy. Sometimes, central banks must take drastic measures.

Such measures are unpopular, and elected governments won’t like them. But independence means keeping the value of money stable, and this principle is on each central bank’s table and mandate.

The concept of money evolved in time. And, it will change still.

From silver and gold coins to today’s fiat money, and maybe tomorrow’s crypto-currencies – money will always play a central role in every society on earth.