The forex market makes up the largest single capital market in the world. With a daily turnover often seen of over $3 trillion, the forex market has no equal in the world of international finance.
For example, the size of the forex market in terms of turnover is considered to be ten times the size of the bond market and fifty times the size of the equity market.
Nevertheless, the popularity of the forex market with smaller traders has had to wait until the relatively recent advent of online retail forex trading accounts.
As the popularity of trading in the forex market increases, more and more traders are finding out that the forex market is not only the largest financial market in the world, but also the deepest and most liquid.
Forex Market Participants
The majority of trading on the foreign exchange market consists of currency transactions made between:
- Major international corporations
- Central banks
- High net worth individuals
While commercial hedging and speculative trading transactions make up a large part of the size of the forex market, central banks often intervene in the markets in large size to prevent excessive currency swings.
The most liquid and widely traded currency in the largest market in the world is the U.S. Dollar. This currency has held that position for quite some time, probably largely due to it being the currency most popularly held in reserve by central banks around the world.
The U.S. Dollar and International Debt
Despite enormous budget deficits, a widening trade deficit, a real estate crisis, and the U.S. Federal Reserve’s apparent willingness to print as many Dollars as it can within its capacity as the United States’ central bank, the U.S. Dollar seems to have a resiliency not seen in other currencies. Why?
The answer to this lies in the fact that the U.S. Dollar was at one time the currency which represented the international standard of value all over the world.
After World War II, most countries had been forced off of the gold standard by the conflict. This made the U.S. Dollar, which was then still convertible into gold, a benchmark currency to which other currencies could be pegged. The Dollar itself was taken off the gold standard in the early 1970s by then-President Richard Nixon.
Since that time, and coupled with the establishment of the International Monetary Fund, the international debt of most countries which actively trade on a global basis is now largely denominated in U.S. Dollars.
In fact, all debt held by the International Monetary Fund is denominated in U.S. Dollars. This means that if a loan is made by the IMF to a third world nation, that nation will receive the funds in Dollars and will have to pay back the loan in Dollars.
Consequently, any attempt to repay the loan or stabilize their national currency would necessitate the trading of Dollars on the forex market.
Key Reserve Currencies
Reserve currencies are those which countries and governments hold “in reserve” for their own foreign exchange dealings. They are also sometimes used to price and purchase key strategic commodities.
In terms of the percentage of global currency reserves, the U.S. Dollar clearly leads all other currencies with 61.5% of world reserves – a key element in many traders’ fundamental analysis for this currency. The Euro follows with 28.1%, the U.K.’s Pound Sterling with 4.2%, and the Japanese Yen with 3.0%.
How did the U.S. Dollar get to become the world’s premier reserve currency?
The answer to this question lies in the fact that the Dollar has been used for many years in the valuation and commercial trading of crude oil, as well as with other key commodities like gold. Read more about how the dollar became the world’s premier reserve currency.