Foreign Exchange

Centuries ago gold or silver coins were used as money. The value of each nation’s money was determined by the gold (or silver) content of each coin. Today, each country has its own currency with names such as forint, dollar, pound, rouble, etc. A distinction is made between domestic currency and foreign currency. A distinction can also be made between foreign currency and foreign exchange.

Foreign exchange is a broader term than foreign currency, as it also includes short term credit instruments (bills of exchange, etc.) in foreign currencies. (Foreign exchange also means the system of dealing in and converting the currency of one country into that of another).

Currencies can be (a) free or convertible (hard) currencies (b) transferable currencies, which can be transferred from one bank to a foreign bank on the basis of agreements, and (c) closed currencies (soft currencies), which can only be used by special arrangement in international payments.

The price at which one currency can be exchanged for another (i.e. the price of a currency on the foreign exchange market) is called the exchange rate or rate of exchange.

Under a floating exchange rate the rates of exchange are determined by market trading based on the supply of and demand for specific currencies. As demand fluctuates, the rates fluctuate also – rising when demand is greater than supply and declining when supply exceeds demand. Under a fixed exchange rate the government keeps the price fixed, in the short run by accumulating or depleting its foreign exchange reserves or else by borrowing abroad or introducing foreign exchange restrictions.

Payments agreements

Payments agreements are concluded between two or more countries (bilateral and multilateral payments agreements) to settle their mutual obligations arising from the exchange of goods, from services mutually rendered and from financial payments, such as wages, salaries, fees, royalties, copyright fees, etc. Payments agreements usually supplement trade agreements.

The most usual type of payments agreements is the clearing-agreement. A clearing-agreement usually contains the following items: the clearing rate of exchange, clearing-accounts, the settlement of the balance on the clearing-account, and some other clauses.

The clearing rate of exchange is the rate which is applied for the conversion of the currency of one country into the currency of the other country. The official rate is usually fixed in advance and remains unchanged during the entire period of the validity of the payments agreement.

All payments between importers of one country and exporters of the other country are settled on the clearing accounts that are opened with the so-called clearing banks (usually banks of issue) in the countries concerned.

When the validity of the payments agreement has expired, the balance on the clearing accounts is stated and the debtor country settles it in one of the following ways: (a) it transfers the balance to the clearing account of a new payments agreement, if such has been concluded: (b) it undertakes to settle the balance by deliveries of goods within a given time after the expiration of the validity of the payments agreement; (e) it agrees to settle the balance in free foreign exchange; (d) it agrees to settle it in gold.