The Foreign Currency Exchange (Forex) is the largest and most liquid market in the world. Investors, companies, and individuals worldwide participate in the Forex, constantly executing millions of formal and informal currency transactions, which amount to approximately US$5.3 trillion daily. The Forex market is highly decentralized and, thus, serves as one of the best mechanisms to gauge the strength of an economy as well as the overall performance of a region. In theory, all of the world’s currencies participate in the Forex. However, merely a dozen of them dominate the vast majority of the Forex market. Throughout the 20th century and into the 21st, the United States Dollar (USD) has dominated as international currency.
International Currency Trade and Trends
The Forex market is made up of currency exchange pairs. For instance, USD:EUR means that the Dollar is exchanged against the Euro. Therefore, the strength of specific currencies within the Forex is measured as a percentage out of 200 basis points, given that two currencies are involved in every transaction. During 2016, the USD was present in 87.6% of all Forex transactions worldwide. This means that the overwhelming majority of currency transactions involve the USD. Since its creation almost two decades ago, the Euro (EUR) has quickly become the second most popular currency in the Forex, participating in approximately 31.3% of all transactions in 2016. These two top currencies are by far the dominant actors within the Forex and the international economy. The third most exchanged currency, particularly dominant in Asian markets, is the Japanese Yen (JPY) used in approximately 21.6% of transactions during 2016.
A particularity of the leading currencies within the Forex is that they are all floating. This means that none of them is backed by precious metals, such as gold or silver, and that their value fluctuates daily based on market sentiment. Certainly, these currencies are managed by their respective central banks and backed by the good faith of their governments. However, in the end, the value and demand of a specific currency is determined mainly by the sense of security that the market feels towards it. Another factor that makes the USD and the EUR dominant world currencies is that international debt obligations are most often managed in these denominations. These obligations include loans from institutions such as the World Bank, the International Monetary Fund (IMF), and even private sector banks. Similarly, the bonds issued by the governments of the United States and the European Union as well as the large amounts of trade involving these regions, make their currencies popular and inevitable for any international investor.
In spite of the financial dominance of the USD and the EUR, it is fair to wonder whether this scenario will change in the future, particularly given the coming of the so-called Asian Century. The fact is that, even though China has become an economic leader in the 21st century, Beijing has thus far held back from an expansionist monetary policy. Nevertheless, as China continues to undergo an economic transformation, it has taken actions that seem to challenge Western hegemony in economic matters.