I first encountered the concept of Qi as a student. Qi is the traditional Chinese medicine term for the circulating life force that flows energetically through us.
I had been suffering from a persistent, hacking cough that lasted for weeks and was hanging out at a Chinese friend’s house finishing a school project. Her mother, a fierce lady, became tired of me coughing all over her house.
After a scolding lecture about my blocked Qi, she thumped me between the shoulder blades, punctured the same spot with some acupuncture needles and applied a patch of traditional Chinese herbs. I’m not sure if it was fear of the process repeating or my Qi moving, but my month-long hacking cough disappeared almost instantaneously.
Money, the life force of our world economy moves around the globe in the form of different sorts of currencies. Much like Qi, it gets stuck and causes trade imbalances and ailing economies.
Foreign exchange trading is that interesting point where currencies collide. These are the exchange rates we deal with as we move through airports and determine prices for our businesses.
Foreign exchange trading is an immense market, the average trading volume exceeding $5 trillion a day. It’s open 24 hours as someone is always needing to buy or sell currencies to keep economic life flowing.
Whether you’re an Amazon trader settling a payment to your Chinese suppliers or a Londoner buying Euros to escape the snow in March (yes, the white stuff is still on the ground here), our economic Qi would disappear without currencies exchanging across borders.
Currency trading is done using a currency pair, for example, USD/GBP or EUR/GBP. The first currency in the pair is called the base and the second is called the counter.
The most traded currency pairs are EUR/USD, USD/JPY, GBP/USD, USD/CHF*. This makes sense given the volume of trades between those nations. The EUR/USD is the most-traded currency pair in the world.
The reason you see two prices whenever you encounter a foreign exchange counter is that one is the buy price and one is the sell. The first price is the buy price (bid). You are buying the first currency in the pair. The second price is the selling price (ask). You are then selling the first currency in the pair. I like to remember it as buy/ sell = bid/ ask. The number quoted is how much the first currency is worth in the second. Just invert the number to get the opposite ratio.
If you think a currency will increase in value, you should buy it and if you think the value will decrease you should sell it. Unless of course, you’re on your way on holiday in which case you have no choice.
So what factors go into determining what is that number flashing at the airport currency exchange counter? I’m going to paraphrase Benjamin Graham (the father of value investing), and say that in the short term the foreign exchange market works like a voting machine and in the long term, it acts like a weighing machine.
In the short term, the value of a nation’s currency appreciation and depreciation is influenced by plain supply and demand from corporations and individuals moving money, speculation and newsworthy events.
In the long term, the value of the currency is likely to be caused by the home country’s inflation being higher or lower than other countries and the monetary policy authorities such as the Fed or the Bank of England, trying to control interest rates.
Policy makers have to balance the needs of their nations importers who will benefit from a stronger currency and exporters who will benefit from a weaker currency.
For example, a bespoke satchel manufacturer in Britain is going to fare better if they can sell it for fewer dollars in New York when the pound is weaker. A solar plant in California is going to like it better when the dollar is strong as they can import solar panels more cheaply from China.
All this currency exchange talk has made me think of airports. A holiday somewhere warm would definitely help my Qi.
USD = United States Dollar
EUR = Euro
JPY = Japanese Yen
GBP = Great British Pound
CHF = Swiss Franc