Why is forex trading so popular
The relationship between foreign exchange and gold
Until the mid-20th century, currencies around the world were tied directly to their respective gold reserves, which controlled the amount of paper money that could be printed and the potential value of the currency. This was called the gold standard because the value of a currency was standardized in gold.
While that controlled national currencies, it also had noticeable drawbacks such as a lack of flexibility and the assumption that all national banks would remain transparent.
In 1973 the US broke away from the gold standard, making gold available for trading on the open market, while the US dollar was supposed to be controlled by the US Federal Reserve. It added unprecedented volatility to the dollar when an entire country switched to a new system of inflation control. Today the dollar has stabilized and investors are watching XAU / USD to closely monitor the price changes between these two valuable financial instruments.
Understanding how central banks use gold today in relation to their currency helps investors understand the relationship between gold and the foreign exchange market.
Gold as currency
The end of the gold standard did not mean the end of gold as an investment. On the contrary, it has enabled gold to become the global "currency" recognized as inherently valuable by investors, individuals, and even governments.
This international recognition created a kind of global currency that governments can exchange for paper money and much more. In contrast to paper money, there is no central bank that would stabilize the value. Instead, value is determined in a free market where governments and investors influence the price. This independence from centralized control reveals a lot about how gold is valued in relation to the world's currencies.
This gives gold significant power over currencies and the governments that hold large reserves of it. When countries have large gold reserves in circulation relative to cash, the currency is considered stable. Should the government decide to sell some of its gold, the value of its currency will increase because it now has more foreign money at its disposal. On the other hand, central banks that want to buy gold in order to stabilize their currency have to print more money in order to be able to make the purchase, which causes their paper currency to lose value, at least temporarily.
Correlation between gold and foreign exchange
The connection between gold and paper currencies is a give and take that has been going on for decades. Countries use gold to increase the value of their currency, but they must first let their currency depreciate in order to buy it.
From an investor's standpoint, gold is another currency that values can be parked in during times of instability or currency inflation.
While there is no guarantee that gold will retain its value, investors rely on historical price developments and estimate that a depreciating paper currency also loses investor confidence and thus continues to fall. Other events that affect the value of a currency include inflation, political uncertainty, significant trade deficits, and other significant events to which its value is tied.
When a currency falls, investors turn to gold. If at any given point in time enough investors turn to gold and create waves in the market, demand will increase without supply increasing accordingly, causing the commodity to increase with demand. On the other hand, when individuals invest in stable currency and the supply of new gold exceeds demand, the price can fall.
For example, if an investor is holding GBP and realizes that there is a large trade deficit within the EU, which has led to the devaluation of the British pound, he could switch to gold as its value could increase compared to the currency he is holding .
On the other hand, an investor holding gold can switch their investment to currencies if the value of the GBP rises.
One of many factors
Gold has an impact on the value and stability of currencies, but it is only one of the many factors that determine the value of a currency. Global markets, political events, central bank decisions, and a whole list of other events can change the value of a currency and the value of gold extremely quickly or gradually.
People who trade in the foreign exchange market can use gold as a further financial instrument and thus, in addition to the movements of international currencies, also conduct transactions on the precious metal.
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