Some basics of trade - Foreign Exchange

Last week I was teaching in my college and an interesting topic came up regarding foreign exchange. The students were keen to know about the foreign exchange and how the foreign exchange actually functions.

So today, I would particularly speak about 'exchange'.

In early days, when there was no currency in use, people used to trade using 'barter' system of trade. People used to give the commodity which they have for exchange of the required commodity. For example, a person would give one pound of grains for having a gallon of milk.

This was an excellent practice when there were less customers, less sellers and the geographical spread was also small.

The earlier trade used to happen on the basis of a barter trade. However the quantification (measurement) of the exchange of good was a problem.

Hence that gave rise to a single medium of exchange which could be measured, has denominations and can be measured for all commodities, services and goods. This gave rise to currency.

Every country was earlier a closed economy. The trade used to happen within the country itself. Hence the trading of goods and services started happening in the currency.

Now, the trades started to cross the boundaries of a country and started to trade goods and services to other countries. This gave rise to the give and take of currencies of each country.
Hence the countries started questioning the denomination or the base for their currency to be traded against other country's currency. This gave rise to the exchange market.

The exchange market reflect the strength or weakness of one currency against the other currency with which it is being traded.
For example, the exchange shows 1 pound = 1.6 Dollars.

Which means that u need to give 0.6 dollar as an addition to trade for some good/service which is labeled in pounds. This theory has a different approach too. However we would cover the same in the later discussions.

So, the way pound and dollar is being compared, all currencies across the world are compared and are being used as a barometer for all global trades and transactions.

Today, the whole world is a truly global economy, whereby all countries are trading good and services all across the world. This trade is increasing with the increase in time.

Hence in coming years, foreign exchange is going to gain much more importance in the global economy and globalized nations.