Financial trading expert Phillip Konchar analyses how the major currencies of the world perform in various economic conditions, plus what holds them all together
Did you know there’s now more physical euros in circulation than dollars, or that Switzerland isn’t the only country using the Swiss franc as it’s official currency? Financial trading expert Phillip Konchar discusses the major currencies of the world and the glue that holds them all together
People are dealing with foreign currencies on a regular basis. Wherever you go on a holiday trip, you’ll likely have to exchange your domestic currency for a foreign one.
Even if you buy noodles imported from China in your grocery store, someone had to pay the Chinese manufacturer in Chinese yuan to be able to import the product.
This way, even if you’re not aware of it, you’ve already been a participant in the world’s largest financial market – the foreign exchange (Forex) market.
This is what makes currencies so fascinating – people use them daily for all kinds of reasons, while traders and investors try to profit on exchange rate fluctuations or hedge against other open positions, such as in commodities.
There is much more behind a currency than what an average consumer might know.
Some currencies may rise in value during times of economic instability, while others closely follow the price of certain commodities.
So let’s take a look into the major currencies of the world.
Rise and fall of the Bretton Woods Agreement – and its impact on major currencies of the world
After the disastrous consequences of the Second World War on the world’s economy, major countries tried to establish rules for financial and monetary relations among them with aims to help rebuild the international economic system.
In 1944, delegates from 44 allied nations gathered in Bretton Woods, in the US state of New Hampshire, and signed the Bretton Woods Agreement.
The agreement’s major features for each country was to adopt a fixed exchange rate regime, which was pegged within a tight band to the US dollar and gold.
Also, two important financial institutions were established to help bridge temporary imbalances of payments and to provide loans for the rebuilding of the world’s economy – the International Monetary Fund and the World Bank.
The Bretton Woods Agreement also tried to prevent competitive currency devaluations.
Since the United States controlled around two-thirds of the world’s gold reserves, US delegates insisted that international currencies rest on both the US dollar and gold.
Although Soviet representatives declined to ratify the agreement, the system became operational after the majority of countries supported the final agreement.
Under the Bretton Woods Agreement, currencies were allowed to fluctuate only within a tight 1% range.
As of 1948, the German mark had a fixed exchange rate of 3.33 to the US dollar, while the Swiss franc and the British pound traded at around 4.30 and 0.35 to the US dollar, respectively.
The US dollar, on the other side, was pegged to gold at a rate of $35 per ounce.
Ultimately, negative balance of payments in the United States, public debt incurred by the Vietnam War and deteriorating gold reserves caused the US dollar to become extremely overvalued and created a heavy burden on the world’s economic growth.
This proved to be the beginning of the end of the Bretton Woods system, which finally collapsed in 1973.
Since then, major countries have adopted a floating exchange rate regime and the Forex market, as we know it today, has been born.
The most traded major currencies of the world
The foreign exchange market, also known as Forex, is the largest financial market with a daily turnover of more than $5tn (£3.77tn), according to the Bank for International Settlements.
Although the United Nations currently recognises 180 currencies, only a handful of them play a major role in international trade.
The US dollar is by far the most important currency, involved in over 80% of all foreign exchange transactions, followed by the euro and Japanese yen – which are used in around 33% and 23% of Forex transactions, respectively.
Here’s a list of major Forex currencies, their main characteristics and other interesting facts.
1) US dollar
The Bretton Woods Agreement has made the US dollar the most important reserve currency and the most-traded currency in the world.
Backed by a strong economy, the US dollar is involved in more than 80% of all Forex transactions, as either the base or counter currency.
The Federal Reserve System was created as a central bank for the US in 1913 by the Federal Reserve Act and is headed by a chairman and board of governors.
The most important body within this is the Federal Open Market Committee (FOMC), which supervises the US monetary policy and open market operations.
Most internationally-traded commodities are denominated in US dollars, including gold, silver and oil.
This often creates an inverse relationship between them – a rising US dollar can lead to a fall in commodity prices and vice-versa.
The euro came into existence on 1 January 1999 as an accounting currency, replacing the European Currency Unit (ECU) at a rate of 1:1.
However, physical banknotes and coins entered into circulation three years later, on 1 January 2002.
Today, the euro is the official currency of 19 of the 28 European Union member states, which form the euro area.
Given its importance for Europe, the euro is also often called the single currency.
It’s a big player, as the second most-traded and the second largest reserve currency in the world after the US dollar.
The European Central Bank acts as the central bank of the 19 member countries of the euro area and is headquartered in Frankfurt, Germany.
The ECB’s Executive Council, which is composed of a president and four members, is the main body of the European Central Bank responsible for making monetary policy decisions.
However, unlike the FOMC – which targets full employment, economic growth and long-term price stability – the ECB’s main target is only price stability.
The Executive Council uses data on inflation to make its interest rate decisions.
Interesting fact: As of 2018, with more than €1.2tn (£1tn) on the market, the euro has surpassed the US dollar in terms of the combined value of coins and banknotes in circulation.
3) British pound
The British pound is the third most traded currency in the world, after the US dollar and the euro.
Together with those two currencies and the Chinese yuan, the pound forms a basket of currencies which is used by the IMF to calculate the value of special drawing rights (SDRs).
The British pound is also a major reserve currency with a share of about 4%.
Investors often refer to the GBP/USD exchange rate as “cable” in the Forex market, since back in the 1800s, the exchange rates for this currency pair were transmitted over the Atlantic Ocean via a transatlantic cable.
The country’s central bank, the Bank of England, was established in 1694 and is one of the world’s oldest banks.
It was privately owned until 1946, when the bank was nationalised.
The bank’s Monetary Policy Committee (MPC) meets every month to decide on changes in monetary policy and interest rates, targeting consumer price inflation of 2%.
The British pound is one of the most volatile major currencies. It’s not unusual that notable cross-pairs, such as GBP/JPY or GBP/AUD, reach an intraday volatility of more than 200 pips.
The US and London sessions usually see the largest movements in GBP-pair.
Interesting fact: The term “British pound”, although informally used, is not an official name of the currency. The full official name is pound sterling.
4) Japanese yen
The Japanese yen is the fourth most traded currency in the world, after the US dollar, the euro and the pound.
The official currency of Japan is also a major reserve currency, after the US dollar, euro and British pound.
Initially, the Japanese yen was pegged to the value of gold and silver by the New Currency Act of 1871.
The Act stated that one yen equals to 1.5 grams of gold or 24.26 grams of silver.
However, with the beginning of the Second World War, the Japanese yen lost much of its value and was fixed at 360 yen per 1 US dollar by the Bretton Woods agreement.
Since the fall of the Bretton Woods system, the Japanese government adopted a policy of currency intervention in an attempt to increase its export competitiveness by keeping a low yen value.
With extremely low interest rates, the Japanese yen has also been often used as the funding currency of carry trades against higher-yielding currencies.
The country’s central bank, the Bank of Japan, has been established since 1882. The Bank’s Monetary Policy Board targets economic stability and growth, and meets 12 to 14 times a year.
Interesting fact: Due to Japan’s high trade surplus and strong export economy, the Japanese yen is considered as a safe-haven currency and often appreciates in times of global political turmoil and economic uncertainty.
5) Swiss franc
The Swiss franc is the official currency and legal tender of Switzerland and Liechtenstein.
It’s a major currency in the foreign exchange market and, just like the Japanese yen, has a safe-haven status. The franc often appreciates in times of global turmoil and uncertainty in Europe.
The country’s central bank, the Swiss National Bank, is different from other central banks as it has both private and public ownership.
Monetary policy decisions are made by three bank heads who meet every three months.
Switzerland is also home of one of the world’s most valuable banknotes – the 1,000 CHF banknote.
At the time of writing and the current exchange rate, the banknote is worth 991 US dollars.
Interesting fact: The ISO code of the currency is CHF, where “CH” is a Latinate and stands for Confoederatio Helvetica. Latin is used for language-neutrality, given the different languages used in Switzerland.
6) Canadian dollar
The Canadian dollar is the official currency in Canada, often abbreviated with C$ to distinguish it from the US dollar.
The currency is often referred to as the loonie, because of the image of a loon on the one-dollar coin.
The Canadian dollar accounts for around 2% of global currency reserves, making it the fifth most held currency after the US dollar, euro, yen and pound.
The country’s central bank, the Bank of Canada targets price and financial stability, and ensures that the currency remains safe and secure.
Just like the Swiss National Bank, the Bank of Canada is sometimes referred to as a corporation owned by the Ministry of Finance, which holds the bank’s shares.
Canada is a major commodity exporter, providing around 43% of US crude oil imports, as of 2015.
This makes the Canadian dollar a commodity-linked currency, which often follows the price of oil on the global market.
Traders and investors also use the Canadian dollar as a hedge against commodity investments.
7) Australian and New Zealand dollars
The Australian dollar is the official currency in Australia and its external territories, including Christmas Island, Cocos Islands and Norfolk Island.
In 2016, the Australian dollar was the fifth most traded currency, accounting for around 7% of daily turnover. The currency replaced the pre-decimal Australian pound in 1966 as a decimal currency.
The New Zealand dollar is the official currency in New Zealand. The currency accounts for around 2% of the daily foreign exchange turnover, making it one of the most traded currencies in the world behind other major currencies.
Both the Australian dollar and the New Zealand dollar are popular among currency traders and investors, given solid economic foundations, political stability and relatively high interest rates in Australia and New Zealand.
This makes them popular choices for carry trades, where low-yielding currencies (such as the Japanese yen) are used to fund positions in higher-yielding currencies.
Both currencies are also heavily dependent on commodity prices, with Australia being a major exporter of iron ore and New Zealand a major producer of dairy products.
Interesting fact: Given the value of trade between China and Australia, the Australian dollar is often heavily influenced by economic conditions in China. A slowdown in Chinese growth often leads to a depreciation of the Australian currency.
Final words on the major currencies of the world
Currencies can be used as a great diversification tool by investors. All mentioned currencies have their own characteristics and behave differently in times of political turmoil, increased risk appetite of market participants or show a strong correlation with the price of certain commodities.
These features make them a great hedge against commodity positions or even against negative price-moves in other financial markets, such as stocks.
Phillip Konchar is the head tutor at My Trading Skills, an online provider of on-demand financial Forex education. Over the past 10 years he has provided trading education and market analysis to a range of financial institutions, including Core Spreads, IG Markets, CMC Markets, Alpari, ETX Capital, FxPro, X-Trade Brokers XTB, GKFX Financial Services, Abu Dhabi Securities ADSL, Admiral Markets and Market Spreads. He specialises in the application of technical analysis in trading.