The Role Of Foreign Exchange In The Economy

The Role Of Foreign Exchange In The Economy


We began the year 2016 with commodity prices going south and stock markets fluctuating randomly; leaving investors with little room to navigate through the murky financial markets waters.

The cooling off of demand in Europe and China served only to worsen the already bad situation, hence dampening the hopes of having a quicker recovery in the markets. However, as the economy faced challenging moments that it is trying to get out of in the second quarter of 2016, traders in the forex markets continued to make money all through.

This market presents a good option to invest your money in even when the global economy is on a gloomy mood.

To get into this exciting financial markets segment and start making money there, you will however need some basic forex education to help you understand how the market works.

Related: Enko Education Investments Matches Money With Passion

The forex market is the largest market segment in the financial world with approximately a daily turnover of about 5 trillion dollars. With millions of traders located in different time zones, the market is usually open on a 24 hour basis hence enabling traders to make money round the clock.

Sasfin banner 2 embed

The beauty of forex trading is that it is not regulated by a central body such as we have the Financial Services Board in South Africa that regulates capital markets and the central bank that regulates the commercial banks and their activities.

In the forex markets, there are unwritten protocols that are followed by all the market players and the whole market is considered to be self-regulating.

Forex markets are not just there by chance by they are there to play a very critical role in facilitating international trade. The term forex by itself it is a short form for “Foreign Exchange”, which simply is the exchange of a local currency for a foreign currency or vice versa.

There are a myriad of reasons why one would like to exchange their local currency for a foreign currency but the major reason is to make international payments.

Multinationals operating in different countries across the world have to buy raw materials and other inputs for their subsidiaries in the foreign countries. In addition, they have to pay their utility bills for their subsidiary offices and pay their employees too.

All the above payments have to be made in the local currency in the country where the subsidiary is located. If the parent country is located in South Africa and the subsidiary is located in the United States of America, then the parent company will need to convert the South African Rand into US dollars for the payments to be made in the US.

Related: Understanding Total Return of Investment

This creates a demand for US dollars which the forex traders will provide to the South African parent company at a given exchange rate. The company will then use the dollars to make payments in the US subsidiary.

In other cases, you may want to travel as an individual to another country either for business or for tourism. If for example you are travelling to Kenya to go and enjoy a Safari Tour in the wilderness of Maasai Mara, you will need Kenyan shillings for all your transactions while you are there.

This again creates the need for an exchange of the local currency with the Kenyan shillings and hence a forex trader is involved in the exchange process.

Governments too borrow from oversees in foreign currencies and they need the foreign currencies for repaying both the interest and principle amounts of the loan when they fall due.

This again creates a demand for the foreign currencies and the exchange happens through the forex markets. When governments and institutions are involved in import and export businesses, again the currency of payment is usually the local currency of the exporter and therefor the importing party has to exchange its own local currency to the currency of the importing country in order to make the payment.


With millions of such transactions described above happening every day, the forex market has undoubtedly to be the largest among all financial market segments.

The trades are usually connected by computer systems and they do all the transactions online. For an individual investor, you get into the market as a speculator who aims to gain from the currency fluctuations.

The exchange rate of a given currency is always determined by the forces of demand and supply. For example, if more dollars are being demanded to make international payments and for imports, the value of the dollar goes up against the South African rand; and when the local currency is being demanded more, then the South African rand appreciates in value against the dollar.

Related: What Are Tax-Free Investments?

As a speculator you get to the market to capitalise on these changes in prices and make a gain. Your involvement is however through an online forex broker who provides the platform on which you trade and you pay them a commission for the services.

Speculators exist in the market to create liquidity but they are not the fundamental reason why the forex market exists. The basic foundation of forex markets is to facilitate international payments and cross-border movement of individuals.

Luis Aureliano
Luis Aureliano, a business writer and financial analyst. With over 15 years of experience in global finance and an MBA in economics and management, Luis’s areas of expertise include business, marketing, communications, personal finance, macro economics, stocks and emerging markets.

Most Read

  • Interesting but what are the charges/fees these traders and banks make? If it’s a digital process then surely they should be small?