Alternate currency systems

The US received a number of advantages in being the world's reserve


currency, especially in the years following the breakdown of the Bretton


Woods system – the US cost of financing was much lower than that of other


countries, allowing it to run greater trade


and financial deficits than those possible for other


countries.

However, such a system encourages economies to run excessive deficits, leaving inflation as the


only escape. The current global currency system is unsustainable –


it has not been effective in dealing with the financial


crisis; the US has a large deficit


that it may need to inflate its way out of; and emerging economies have had the incentive to


continually undervalue their currencies against the USD to make their exports more attractive, now believing that they would


not succeed if they allowed their currencies


to appreciate naturally.

Then what is the alternative?

Restoring the gold standard is impractical – a pure gold standard tends to


be deflationary, while a not-so-pure gold standard based on derivatives could


be manipulated like the current currency system.

A global currency is another possibility, and was suggested by John Maynard Keynes. However, current problems


with the eurozone highlight how unrealistic it is to have a single


currency representing relatively independent economies, with widely varying


industries and political systems To be successful, a common


currency would require a loss of sovereign power to a certain degree, with one


agency overseeing trade policy, including limiting surpluses and monetary


policy to avoid inflationary temptations.

Another alternative was suggested in early 2011 when the IMF issued a report on Special Drawing Rights (SDR) as a replacement


for the USD as the world’s reserve currency.







In 1969, SDR's were created as a more limited


global currency. They can be converted into a required currency at exchange


rates based on a weighted-basket of currencies.


When the IMF issues funds to economies, they are typically dominated in SDRs, the largest such issue being the


equivalent of USD250 billion in April 2009 in response to the private-lending


collapse in the financial crisis.

It is argued that they would be a less volatile alternative to the dollar,


despite not being a tangible currency.







Increasing the global role of SDRs and issuing more SDRs would reduce the


current problem of recessionary bias – during and after financial crises, the


burden of adjusting to payments imbalances falls on nations running large


deficits, the US in particular – by allowing central banks to


exchange the SDRs for hard currency, rather than exchanging dollars.


This would also reduce the need for countries to accumulate reserves,


facilitating a reduction in the global imbalances that result from countries


stockpiling USDs. And, the smaller scale of SDRs would help


sustain the recovery of the global economy without leading to inflation. That


being said, the final point is dependent on the IMF members limiting the


introduction of SDRs into the market over the next few years.







If you have an opinion on the future direction of the USD, or which


currencies will perform well in the global economy, why not try forex trading? Trading is available on a range of


currencies, the most common currency pairs being the EUR/USD, GBP/USD, JPY/USD,


USD/CHF and AUD/USD.









Remember that CFDs and forex trading are leveraged products and can lead to losses that exceed your 1st deposit. CFD trading may not be appropriate for everybody, so please ensure that you fully understand the risks concerned.     

Spreads and forex trading

Currency exchange is


often advertised as being


a commission-free market, with no exchange charges, regulatory


charges or data charges.

 However, currency


exchange providers do need to


earn money somewhere, and this is


generally done through ask/buy spreads.

 The


ask/buy spread is how a currency pair is quoted; the ask


price is the price at which traders can sell the pair, while the


buy price is the price at which traders can buy the pair. If


the EUR/USD pair was quoted at 1.4441 / 1.444, traders could sell


the pair at 1.4441 and buy it at 1.4444. This is a


range of 3 pips, or 3 units of 0.0001.

 There are 3


ways in which most currency exchange


providers earn money on spreads, through


offering fixed spreads, variable spreads or a commission based on a percentage of the spread.

 In the case of the


EUR / USD forex pair, if you were trading through a currency


exchange provider that offered a fixed


spread, the quoted spread would always be 3 pips, regardless


of market liquidity.

 Currency


exchange providers that offer variable spreads


could have spreads as little as one pip, or as big


as 5. These spreads are typically


based on the liquidity of a currency pair; if


the pair is awfully liquid, the spread is


generally narrower, and if the pair is not, the spread


is generally broader. The most


commonly traded currency pairs , for example


the USD/JPY, USD/CHF, GBP/USD, AUD/USD and EUR / USD, are more liquid and have lower spreads.


By contrast, exotic currency pairs , for example the USD/ZAR, are traded less


frequently so are less liquid and sometimes have


higher spreads.







Variable spreads could also alter


at different times of the trading day or different times of


the week when the volume of fx trades is higher or lower.







Other currency


exchange providers may charge a small commission


, for example two-tenths of a pip (or 0.00002), and then pass


your order onto an enormous market maker with whom it has a relationship. Such an arrangement could end in you receiving tight spreads that only


huge traders could receive otherwise.

So which is best?

Fixed spreads may protect traders from slippage,


which is when your trade is executed at a different price to the one you were


offered, due to underlying market liquidity. You may also


always know what price you may pay for a currency pair.


But in the long run this


frequently works out to be costlier


than variable spreads.

 In the case of forex providers that charge


commissions, it is worth finding out what else


the provider is offering. If you are charged a 0.00002 commission on


your trade, but are offered a software platform that is better than most online providers, it could be worth paying the additional cost.

 Variable spreads are


attractive because they should mirror the underlying


market ; however, the


effectiveness of this depends on


how well providers can make the market.

 As currency


exchange is an OTC market, banks, the first market makers, have


relations with other banks and online currency


exchange providers, and these


relations are based mostly on the capitalisation and


credit standing of each


establishment. Foreign exchange providers that


offer variable spreads will be able to pass on more


competitive spreads to its clients if they are


well-capitalised and have a good relationship with a


bunch of credible banks.     









Remember that CFDs and forex trading are leveraged products and can result in losses that exceed your 1st deposit. CFD trading may not be appropriate for everybody, so please ensure that you fully understand the risks concerned.