Foreign exchange market

Foreign exchange is bought and sold by a diversity of persons and institutions in a nation-wide "open" or "over-the-counter" market. If governments leave foreign exchange trading in private hands the transactions ordinarily converge upon the principal financial centers and will be carried on chiefly by the large international banks. When foreign exchange is a government monopoly the market immediately becomes highly centralized, although as a result of the restrictions bootleg or illegal trading frequently develops. In the United States foreign exchange trading is not materially regulated by the government. Consequently the market is "free" in that supply and demand are virtually unrestricted in the determination of exchange rates.

The rate-making forces are the subject of the next chapter. It is necessary here to call attention to the rather obvious fact that in the United States there is at all times both a demand for foreign exchange and a supply of foreign exchange. Exchange is created chiefly by those persons and companies that have sold goods and services to foreigners or that have foreign-currency balances derived either from borrowing or from foreign ventures. Some of these "creators" of exchange can use it themselves. For example, an exporter of tin plate might find it convenient to use some of the exchange received in payment to pay for imported raw materials. On the whole, however, the exporter of goods, services, or securities will sell the resulting foreign exchange for its dollar equivalent. On the other hand the Americans and the American companies who have incurred debts abroad--by importing, for example--must buy foreign exchange to make settlement. It is the function of the dealers and brokers in the foreign exchange market to serve as intermediaries between these two groups.

In the United States, New York City is the principal center of foreign exchange operations. New York banks have the most elaborate foreign departments; and in this city is the greatest concentration of import and export offices. The great New York banks stand ready to buy or sell, at some price, almost any international currency for which, to their knowledge, there is a ready market. At certain periods of the year the larger travel organizations, such as the American Express Company, are also largescale wholesale dealers in foreign exchange. Banks in certain other large cities in the United States are independent of New York institutions for foreign exchange facilities, as they too in many instances are wholesale buyers and sellers of exchange on their own account.

In recent years banks have been overwhelmingly the most important factor in the foreign exchange market both as buyers and sellers and as intermediaries in the collection of dollar and foreign-currency drafts. With the motivating factor of profit as the principal incentive, the banks buy foreign exchange in order to be in a position to sell foreign exchange. They purchase foreign bills in order to build up foreign-currency balances abroad against which they may sell their own drafts. For this service they expect to earn the spread between the buying and selling rates. An importer or anyone else who needs exchange to pay an obligation in foreign currency most probably will purchase a sight draft or cable or mail transfer in the appropriate foreign currency, from an exchange banker.

In passing, reference might be made to the foreign exchange broker, whose principal function at present is almost entirely confined to operating as liaison in interbank exchange transactions. The broker acts as an agent, not as a principal, and depends on commissions for his income.