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Forex: Importance in Importing and Exporting Goods

Importing goods and services correspondingly tends to cause the home currency to be sold in order to buy foreign currency. If the United States imports, say, a million dollars of British automobiles, then somebody is likely to want to sell a million dollars to get pounds.

If the U.S. importer is allowed to pay in dollars, the British exporter of the automobiles faces the task of selling the million dollars to get pounds if he wants to end up holding his home currency. If the British exporter insists on being paid in pounds, it is the U.S. importer of the autos that must take a million dollars to the foreign exchange market in search of pounds.

Eitherway, U.S. imports of goods and services will create a demand for foreign currency and a supply of the home currency, to the extent that U.S. importers have dollars to offer and foreign exporters are happy to hold onto dollars; or the U.S. importers somehow have larger reserves of foreign currencies to spend. It lets the U.S. imports keep from generating a supply of dollars and a demand for foreign currency.

The traders entering the foreign exchange market in order to exchange currencies seldom transact directly with each other.

Rather each other trader deals with a bank, usually in his own country. The large banks accustomed to foreign exchange dealings then buy and sell currencies among themselves and with specialized foreign exchange brokers.

It is in these interbank and bank-broker dealings that the foreign exchange rates are set, with the traders simply being told by banks what the current rates are. It is also because banks remain the core of the foreign exchange market that exchange-rate quotations released by major banks and not by exporters or importers.

Thus, the U.S. firm selling aircraft exports in exchange for payment in pounds would take the British importer's promise to repay and sell it to a U.S. bank, which sells this IOU in sterling to another bank wanting to buy sterling with dollars.

The dollar checking accounts thus received by the U.S. bank compensate it for the dollars it paid to the U.S. aircraft exporter; along with small fees pocketed by the bank for helping the exporter get rid of his sterling.

In financial jargon, one could reexpress this pair of transactions as follows: The U.S. aircraft exporter 'draws a bill on London' and 'discounts' it with a U.S. bank, which 'rediscounts' it, 'repatriating' its proceeds through the foreign exchange market.