Chapter 3-2 Characteristics of the World’s Major Currencies
There are over a hundred currencies currently trading around the world. While this may sound like a lot, the majority of these currencies is somewhat irrelevant in the global economy, and serves little purpose to the investing community. In practice, there are nine currencies, each representing one of the world’s major economic powers that account for about 99% of the currency dollar value traded around the world. To be a successful currency trader it is imperative that you familiarize yourself as much as possible with these currencies as they will almost certainly make up the majority of your trading volume as well.
United States Dollar
The United States is the world’s largest economy and as a result is the focal point for many of the discussions on global economics. Its main economic partners are China, Canada, Mexico, Japan, and the European Union. The Federal Reserve Board, lead by Chairman Ben Bernanke, is the governing body in charge of monetary policy. The Fed’s main purpose is to maintain stability in the prices of goods and services and to ensure sustainable economic growth. Currently, monetary policy is aimed at maintaining a strong dollar, or a high exchange rate vs. the rest of the world. The main drivers in US dollar price fluctuations are economic developments at home and abroad, bond yields, interest rates, and balance of trade.
The European Union is an economic union of 27 nations that was founded through the Treaty of Maastricht in 1993. Of these 27 nations, 16 have adopted the Euro as their primary currency; these nations are collectively referred to as the Eurozone. The Eurozone is the world’s second largest economy and consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. The Eurozone’s main trading partners are China, the United States, Russia, and Switzerland. The European Central Bank, lead by President Jean-Claude Trichet, is the governing body in charge of monetary policy. The European Central Bank’s main purpose is to maintain stability across the Eurozone by ensuring member states meet the standards set forth by the Treaty of Maastricht. The main criteria are inflation within 1.5% of the top three lowest member nations, interest rates within 2% of the top three member nations, and government deficit less than 3% of Gross Domestic Product. The main drivers in Euro price fluctuations are GDP reports amongst member nations, employment data, budget balance, consumer price index, and the overall performance of Germany’s economy- the largest economy within the EU. The EUR/USD currency pair is the most actively traded pairing in the world, and as such is the most commonly used when seeking Euro exposure. Recently, however, traders have been using the EUR/JPY, EUR/CHF, and EUR/GBP more and more as a means for a nontraditional exposure.
United Kingdom Pound Sterling
The United Kingdom is a European Union member that has chosen not to adopt the Euro as its currency, using the Pound Sterling instead. At one point in time the United Kingdom was the world’s largest economy, much like the United States is today, but has since fallen back to number six. Its main trading partners are the United States, Germany, and China, although plenty of trade occurs between the UK and individual EU member states. The Bank of England, led by governor Mervyn King, is the governing body in charge of monetary policy. The Bank of England’s main purpose is to ensure price stability while promoting economic growth and maintaining readily available employment opportunities. As a member of the European Union, the GBP/USD currency pair often behaves similarly to the EUR/USD pairing despite not being a Eurozone currency member. There is, however, one main difference: liquidity. The GBP/USD is significantly less liquid that the EUR/USD and therefore is more prone to volatility spikes. In some instances this is actually desirable- trading news releases for example as the GBP/USD paring will experience a bigger move following the report. The main drivers in Pound Sterling price fluctuations are the unemployment rate, consumer price index, GDP, purchasing managers index, UK monetary policy, and the economic climate in the European Union and United States.
Japan has used its status as one of the world’s largest importers and exporters to climb all the way up the rankings- it’s currently the world’s third largest economy. Due to its size and terrain, Japan has often relied on trade as its main economic competency. This has not been a problem as its main trading partners (the United States, China, and the European Union) have maintained a strong demand for Japanese products, particularly motor vehicles and electronic goods. Japan has two main financial governing bodies: the Bank of Japan and the Ministry of Finance. The Ministry of Finance handles policy with regards to foreign partners while the Bank of Japan controls domestic monetary policy. This is unlike most arrangements in which the government and central bank are independent entities, and thus provides for some interesting internal conflicts. Similar to the United States strong dollar stance, Japan maintains a no interest policy by keeping key interest rates at .1%. As a result, the Bank of Japan cannot really lower interest rates and therefore must rely on other measures to stimulate the economy. The USD/JPY is the second most heavily traded currency pair, behind the EUR/USD, which makes sense as Japan is one of the premier players in international trade. The main drivers in Yen price fluctuations are GDP, trade balance, employment rates, core machine orders, and actions taken by the Bank of Japan to maintain a favorable trade environment.
The People’s Republic of China is the most populous nation on earth and has recently grown to be the world’s second largest economy. Up until the late 1980’s China had very little influence on the world’s economy, it mostly served as an outsourcing location for cheap labor. Although the economy is still export-driven, a growing middle class has increased the presence of import and service based economic growth. China’s main trading partners are the United States, the European Union, Japan, and South Korea. As a communist nation, it is no surprise that there is significant government intervention in the economy, both on a local and international scale. The two most influential government bodies are the People’s Bank of China and the Ministry of Finance. These two governing bodies look to control inflation, stabilize the value of the Yuan, and maintain favorable conditions for China’s strong balance of trade. The main drivers of Yuan price fluctuations are GDP, balance of trade, economic growth in the United States and European Union, and commodity prices.
Canadian Dollar (Loonie)
Canada has used its vast natural resources and open trade policy very effectively to land itself as the world’s 10th largest economy. Canada’s main trading partners are fellow NAFTA members the United States and Mexico, with the remainder of its trade occurring with China and the United Kingdom. Canada and the United States share the world’s longest border and naturally the majority of trade occurs between the two nations, with the United States receiving over 75% of Canadian exports. The Bank of Canada, lead by Governor Mark Carney, is the nation’s financial governing body. Like other central banks, the Bank of Canada looks to stabilize the value of the nation’s currency while keeping inflation within their target of 1-3%. As a natural resource export driven economy, the Canadian dollar, nicknamed the Loonie, is highly correlated to commodity prices (oil in particular). The main drivers in Canadian dollar price fluctuations are the consumer price index, GDP, trade balance, commodity prices, US economic data, and US/Canadian mergers and acquisitions.
Australian Dollar (Aussie)
Australia is an island nation in the South Pacific that contains the 13th largest economy in the world. Although this ranking is outside of the top ten, this translates to one of the highest standards of living due to the low population. Furthermore, Australia’s economy has been growing at an average of 3.5% annually for the past few decades, far outpacing the 2.5% global standard. Australia is primarily a service oriented economy; however its main trading partners are China, the United Sates, and Japan. The Reserve Bank of Australia, lead by Governor Glenn Stevens, is the country’s governing body when it comes to monetary and fiscal policy. The Reserve Bank has three primary objectives: exchange rate stability, sustainable growth, and full employment. Their policy is based around inflation, growth occurs when the currency is secure which is achieved by keeping inflation between 2 and 3%. Similar to Canada, Australia’s dollar, nicknamed the Aussie, is a commodity driven dollar with gold being the primary driver rather than oil. The main drivers in Australian dollar price fluctuations are the consumer price index, GDP, trade balance, commodity prices, interest rates, and information on China’s economic situation.
New Zealand Dollar (Kiwi)
New Zealand is a small island nation in the South Pacific that relies heavily on trade as an economic drive much like its neighbor to the north Australia. Although their economy is small on a global scale, ranking 52nd in the world, New Zealand is a major trade partner with the United States, Australia, Japan, and Germany making its currency very relevant in the global Forex market. Similar to Australia and Canada, New Zealand is an export driven economy with a focus on natural resources. The Reserve Bank of New Zealand, lead by Governor Alan Bollard, is the governing body in charge of fiscal and monetary policy. The RBNZ’s main concerns are price stability, interest rates, economic output, exchange rates, and maintaining a target 1.5% inflation rate. The New Zealand dollar, nicknamed the Kiwi, is a commodity dollar that is most heavily influenced by agricultural products. For fairly straightforward reasons- being neighbors with very similar economies, the Kiwi and the Aussie are highly correlated. The main drivers for fluctuations in the New Zealand dollar are economic growth, balance of trade, commodity prices, immigration, and favorable weather conditions.
Switzerland is a small nation in the middle of Europe that, oddly enough, is not a member of the European Union. Switzerland has maintained political and economic neutrality for most of its existence and thus has some very significant economic characteristics. Despite its size, Switzerland enjoys the 19th largest economy and one of the highest standards of living in the world. Switzerland maintains very favorable tax rates and bank secrecy laws that make it one of the most attractive places on earth to do business. Switzerland’s main economic partners are the United States and the European Union, Germany in particular. The Swiss National Bank, lead by Chairman Philip Hildebrand, is the nation’s governing body on monetary policy. The Swiss National Bank’s primary concerns are with money supply, interest rates, and stabilizing the Swiss Franc’s value. As an export driven economy Switzerland is highly susceptible to the negative effects of an overvalued currency and therefore uses its cast capital resources to influence the Francs value as often as necessary. Additionally, the SNB looks to keep inflation below 2% a year. The main drivers in Swiss Franc price fluctuations are GDP, inflation, balance of trade, gold valuation, and economic activity in the European Union and United States.
As you can see there are a number of factors to consider when comparing the world’s major economic powers to one another. Although Gross Domestic Product (GDP) is the most commonly used, Forex traders can gain an invaluable advantage by looking beyond this to the less publicized characteristics and discovering things that the general investing community might not yet be privy to. Similar to the importance of knowing the ins and outs of various stocks in the stock market, knowing as much as you can about the various currencies around the world is crucial to success in the Forex market.