INTERNATIONAL EXCHANGE

also called Foreign Exchange, the market in which national currencies are bought and sold by those who require them for various transactions. The sellers and buyers may include exporters, importers, multinational corporations, persons wishing to send money gifts to friends or relations, or governments. The market in currencies operates much like any other market, with principals interested in doing business and intermediates who profit by arranging the transactions and in so doing helping maintain a stable and organized set of prices. The principal difference between the international exchange market and markets for other goods is the existence of a parity price established for each currencyi.e., an equality of purchasing power established by law between different currencies at a given ratio. Parity is determined by the government responsible for a given currency in terms of a gold valuation registered with the International Monetary Fund (IMF). Actual prices quoted on the market fluctuate constantly and are almost always different from the parity price but may not deviate from it by more than a set amount without provoking government intervention to restore the price to its proper range. The art of the middlemen is arbitrage (q.v.), and its effect is to smooth out the temporary price discrepancies from which the arbitrageur profits and thus reduce the necessity for official interventions in the market. When intervention becomes necessary it usually takes the form of selling currencies by central banks in such amounts as to satisfy the unusually strong demand that has driven up those currencies' price relative to the national currency. Another tool used by governments is the manipulation of short-term interest rates, by which inflows or outflows of capital may be encouraged. Transactions in which one currency is exchanged directly for another are called spot transactions. Many transactions involve contracts to exchange currencies at a specified rate on a specified future date; these are forward exchanges. In forward exchanges, differences in the short-term interest rates in the countries involved must be taken into account in order to achieve interest parity. Again, in forward transactions the agency of the arbitrageur and occasionally the intervention of governments serve to smooth fluctuations in price. Forward transactions make it possible for debtors and creditors to protect themselves against possible large changes in exchange rates (i.e., devaluations or revaluations of national currencies) by covering, or making forward commitments opposite the future payment or receipt; they also allow for hedging, whereby asset holders may by similar means protect against losses due to large exchange-rate changes. The anticipation of such changes will also incite speculation in currencies, which frequently has the effect of multiplying movements of funds in international markets.