Currency

For other uses, see Currency (disambiguation).

A currency (from Middle English: curraunt, "in circulation") in the most specific use of the word refers to money in any form when in actual use or circulation, as a medium of exchange, especially circulating paper money.
This use is synonymous with banknotes, or (sometimes) with banknotes plus coins, meaning the physical tokens used for money by a government.[1][2] A much more general use of the word currency is anything that is used in any circumstances, as a medium of exchange. In this use, "currency" is a synonym for the concept of money.[3] A definition of intermediate generality is that a currency is a system of money (monetary units) in common use, especially in a nation.[4] Under this definition, British pounds, U.S. dollars, and European euros are different types of currency, or currencies. Currencies in this definition need not be physical objects, but as stores of value are subject to trading between nations in foreign exchange markets, which determine the relative values of the different currencies.[5] Currencies in the sense used by foreign exchange markets, are defined by governments, and each type has limited boundaries of acceptance. The former definitions of the term "currency" are discussed in their respective synonymous articles banknote, coin, and money. The latter definition, pertaining to the currency systems of nations, is the topic of this article.

History

Early currency

This section does not cite any references or sources.

(October 2011) Cowry shells being used as money by an Arab trader. Currency evolved from two basic innovations, both of which had occurred by 2000 BC. Originally money was a form of receipt, representing grain stored in temple granaries in Sumer in ancient Mesopotamia, then Ancient Egypt. In this first stage of currency, metals were used as symbols to represent value stored in the form of commodities. This formed the basis of trade in the Fertile Crescent for over 1500 years. However, the collapse of the Near Eastern trading system pointed to a flaw: in an era where there was no place that was safe to store value, the value of a circulating medium could only be as sound as the forces that defended that store. Trade could only reach as far as the credibility of that military. By the late Bronze Age, however, a series of treaties had established safe passage for merchants around the Eastern Mediterranean, spreading from Minoan Crete and Mycenae in the northwest to Elam and Bahrain in the southeast. It is not known what was used as a currency for these exchanges, but it is thought thatox-hide shaped ingots of copper, produced in Cyprus, may have functioned as a currency. It is thought that the increase in piracy and raiding associated with the Bronze Age collapse, possibly produced by the Peoples of the Sea, brought this trading system to an end. It was only with the recovery of Phoenician trade in the 10th and 9th centuries BC that saw a return to prosperity, and the appearance of real coinage, possibly first in Anatolia with Croesus of Lydia and subsequently with the Greeks and Persians. In Africa many forms of value store have been used, including beads, ingots, ivory, various forms of weapons, livestock, the manilla currency, and ochre and other earth oxides. The manilla rings of West Africa were one of the currencies used from the 15th century onwards to buy and sell slaves. African currency is still notable for its variety, and in many places various forms of barter still apply.

Coinage

Coin These factors led to the metal itself being the store of value: first silver, then both silver and gold, and at one point also bronze. Now we have copper coins and other non-precious metals as coins. Metals were mined, weighed, and stamped into coins. This was to assure the individual taking the coin that he was getting a certain known weight of precious metal. Coins could be counterfeited, but they also created a new unit of account, which helped lead to banking.
Archimedes' principle provided the next link: coins could now be easily tested for their fine weight of metal, and thus the value of a coin could be determined, even if it had been shaved, debased or otherwise tampered with (see Numismatics). Most major economies using coinage had three tiers of coins: copper, silver and gold. Gold coins were used for large purchases, payment of the military and backing of state activities. Silver coins were used for mid sized transactions, and as a unit of account for taxes, dues, contracts and fealty, while copper coins were used for everyday transactions. This system had been used in ancient India since the time of the Mahajanapadas. In Europe, this system worked through the medieval period because there was virtually no new gold, silver or copper introduced through mining or conquest. Thus the overall ratios of the three coinages remained roughly equivalent. 

Paper money

Banknote In pre modern China, the need for credit and for a medium of exchange that was less physically cumbersome than large numbers of copper coins led to the introduction of paper money, i.e. banknotes. Their introduction was a gradual process which lasted from the late Tang Dynasty (618–907) into the Song Dynasty (960–1279). It began as a means for merchants to exchange heavy coinage for receipts of deposit issued as promissory notes by wholesalers' shops. These notes that were valid for temporary use in a small regional territory. In the 10th century, the Song Dynasty government began to circulate these notes amongst the traders in its monopolized salt industry. The Song government granted several shops the right to issue banknotes, and in the early 12th century the government finally took over these shops to produce state-issued currency. Yet the banknotes issued were still only locally and temporarily valid: it was not until the mid 13th century that a standard and uniform government issue of paper money became an acceptable nationwide currency. The already widespread methods of woodblock printing and then Pi Sheng's movable type printing by the 11th century were the impetus for the mass production of paper money in pre modern China.
Song Dynasty Jiaozi, the world's earliest paper money At around the same time in the medieval Islamic world, a vigorous monetary economy was created during the 7th–12th centuries on the basis of the expanding levels of circulation of a stable high-value currency (the dinar). Innovations introduced by Muslim economists, traders and merchants include the earliest uses of credit,[6] cheques, promissory notes,[7] savings accounts, transactional accounts, loaning, trusts, exchange rates, the transfer of credit and debt,[8] and banking institutions for loans and deposits.[8] In Europe, paper money was first introduced on a regular basis in Sweden in 1661 (although Washington Irving records an earlier emergency use of it, by the Spanish in a siege during the Conquest of Granada). Sweden was rich in copper, thus, because of copper's low value, extraordinarily big coins (often weighing several kilograms) had to be made. The advantages of paper currency were numerous: it reduced the need to transport gold and silver, which was risky; it facilitated loans of gold or silver at interest, since the underlying specie (gold or silver) never left the possession of the lender until someone else redeemed the note; and it allowed a division of currency into credit and specie backed forms. It enabled the sale of stock in joint stock companies, and the redemption of those shares in paper. But there were also disadvantages. First, since a note has no intrinsic value, there was nothing to stop issuing authorities printing more notes than they had specie to back them with. Second, because it increased the money supply, it increased inflationary pressures, a fact observed by David Hume in the 18th century. Thus paper money would often lead to an inflationary bubble, which could collapse if people began demanding hard money, causing the demand for paper notes to fall to zero. The printing of paper money was also associated with wars, and financing of wars, and therefore regarded as part of maintaining a standing army. For these reasons, paper currency was held in suspicion and hostility in Europe and America. It was also addictive, since the speculative profits of trade and capital creation were quite large. Major nations established mints to print money and mint coins, and branches of their treasury to collect taxes and hold gold and silver stock. At that time, both silver and gold were considered legal tender, and accepted by governments for taxes. However, the instability in the ratio between the two grew over the course of the 19th century, with the increases both in supply of these metals, particularly silver, and in trade. The parallel use of both metals is called bimetallism, and the attempt to create abimetallic standard where both gold and silver backed currency remained in circulation occupied the efforts of inflationists. Governments at this point could use currency as an instrument of policy, printing paper currency such as the United States Greenback, to pay for military expenditures. They could also set the terms at which they would redeem notes for specie, by limiting the amount of purchase, or the minimum amount that could be redeemed. By 1900, most of the industrializing nations were on some form of gold standard, with paper notes and silver coins constituting the circulating medium.
Private banks and governments across the world followed Gresham's Law: keeping the gold and silver they received, but paying out in notes. This did not happen all around the world at the same time, but occurred sporadically, generally in times of war or financial crisis, beginning in the early part of the 20th century and continuing across the world until the late 20th century, when the regime of floating fiat currencies came into force. One of the last countries to break away from the gold standard was the United States in 1971.
No country anywhere in the world today has an enforceable gold standard or silver standard currency system.

Banknote era

Banknote and Fiat currency

A banknote (more commonly known as a bill in the United States and Canada) is a type of currency, and commonly used as legal tender in many jurisdictions. With coins, banknotes make up the cash form of all money. Banknotes are mostly paper, but Australia's Commonwealth Scientific and Industrial Research Organisation developed the world's first polymer currency in the 1980s that went into circulation on the nation's bicentenary in 1988. Now used in some 22 countries (over 40 if counting commemorative issues), polymer currency dramatically improves the life span of banknotes and prevents counterfeiting.

Modern currencies

Tables of historical exchange rates to the United States dollar Currencies exchange logo To find out which currency is used in a particular country, check list of circulating currencies. Currency use is based on the concept of lex monetae; that a sovereign state decides which currency it shall use.
Currently, the International Organization for Standardization has introduced a three-letter system of codes (ISO 4217) to define currency (as opposed to simple names or currency signs), in order to remove the confusion that there are dozens of currencies called the dollar and many called the franc. Even the pound is used in nearly a dozen different countries; most of these are tied to the Pound Sterling, while the remainder have varying values. In general, the three-letter code uses the ISO 3166-1 country code for the first two letters and the first letter of the name of the currency (D for dollar, for instance) as the third letter. United States currency, for instance is globally referred to as USD. The International Monetary Fund uses a variant system when referring to national currencies.

Alternative currencies

Alternative currency Distinct from centrally controlled government-issued currencies, private decentralized trust networks support alternative currencies such as Bitcoin, as well as branded currencies, for example 'obligation' based stores of value, such as quasi-regulated Barter Card, Loyalty Points (Credit Cards, Airlines) or Game-Credits (MMO games) that are based on reputation of commercial products, or highly regulated 'asset backed' 'alternative currencies' such as mobile-money schemes like MPESA (called E-Money Issuance).[9] Currency may be Internet-based and digital, for instance, Bitcoin[10] and not tied to any specific country, or the IMF's SDR that is based on a basket of currencies (and assets held). 

Control and production

In most cases, a central bank has a monopoly right to issue of coins and banknotes (fiat money) for its own area of circulation (a country or group of countries); it regulates the production of currency by banks (credit) through monetary policy. An exchange rate is the price at which two currencies can be exchanged against each other. This is used for trade between the two currency zones. Exchange rates can be classified as either floating or fixed.
In the former, day-to-day movements in exchange rates are determined by the market; in the latter, governments intervene in the market to buy or sell their currency to balance supply and demand at a fixed exchange rate. In cases where a country has control of its own currency, that control is exercised either by a central bank or by a Ministry of Finance. The institution that has control of monetary policy is referred to as the monetary authority. Monetary authorities have varying degrees of autonomy from the governments that create them. In the United States, the Federal Reserve System operates without direct oversight by the legislative or executive branches. A monetary authority is created and supported by its sponsoring government, so independence can be reduced by the legislative or executive authority that creates it. Several countries can use the same name for their own separate currencies (for example, dollar in Australia, Canada and the United States). By contrast, several countries can also use the same currency (for example, the euro), or one country can declare the currency of another country to be legal tender.
For example, Panama and El Salvador have declared U.S. currency to be legal tender, and from 1791 to 1857, Spanish silver coins were legal tender in the United States. At various times countries have either re-stamped foreign coins, or used currency board issuing one note of currency for each note of a foreign government held, as Ecuador currently does. Each currency typically has a main currency unit (the dollar, for example, or the euro) and a fractional unit, often defined as 1⁄100 of the main unit: 100 cents = 1dollar, 100 centimes = 1 franc, 100 pence = 1 pound, although units of 1⁄10 or 1⁄1000 occasionally also occur. Some currencies do not have any smaller units at all, such as the Icelandic króna. Mauritania and Madagascar are the only remaining countries that do not use the decimal system; instead, the Mauritanian ouguiya is in theory divided into 5 khoums, while the Malagasy ariary is theoretically divided into 5 iraimbilanja. In these countries, words like dollar or pound "were simply names for given weights of gold."[11] Due to inflation khoums and iraimbilanja have in practice fallen into disuse. (See non-decimal currencies for other historic currencies with non-decimal divisions).

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What Is Forex?The foreign exchange market is the "place" where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can't pay in euros to see the pyramids because it's not the locally accepted currency. As such, the tourist has to exchange the euros for the local currency, in this case the Egyptian pound, at the current exchange rate.

The need to exchange currencies is the primary reason why the forex market is the largest, most liquid financial market in the world. It dwarfs other markets in size, even the stock market, with an average traded value of around U.S. $2,000 billion per day. (The total volume changes all the time, but as of August 2012, the Bank for International Settlements (BIS) reported that the forex market traded in excess of U.S. $4.9 trillion per day.)

One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted electronically over-the-counter (OTC), which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - across almost every time zone. This means that when the trading day in the U.S. ends, the forex market begins anew in Tokyo and Hong Kong. As such, the forex market can be extremely active any time of the day, with price quotes changing constantly.

Spot Market and the Forwards and Futures Markets There are actually three ways that institutions, corporations and individuals trade forex: the spot market, the forwards market and the futures market. The forex trading in the spot market always has been the largest market because it is the "underlying" real asset that the forwards and futures markets are based on. In the past, the futures market was the most popular venue for traders because it was available to individual investors for a longer period of time. However, with the advent of electronic trading, the spot market has witnessed a huge surge in activity and now surpasses the futures market as the preferred trading market for individual investors and speculators. When people refer to the forex market, they usually are referring to the spot market. The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.

What is the spot market?More specifically, the spot market is where currencies are bought and sold according to the current price. That price, determined by supply and demand, is a reflection of many things, including current interest rates, economic performance, sentiment towards ongoing political situations (both locally and internationally), as well as the perception of the future performance of one currency against another. When a deal is finalized, this is known as a "spot deal". It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, the settlement is in cash. Although the spot market is commonly known as one that deals with transactions in the present (rather than the future), these trades actually take two days for settlement.

What are the forwards and futures markets?Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead they deal in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement.

In the forwards market, contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves.

In the futures market, futures contracts are bought and sold based upon a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In the U.S., the National Futures Association regulates the futures market. Futures contracts have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized. The exchange acts as a counterpart to the trader, providing clearance and settlement.

Both types of contracts are binding and are typically settled for cash for the exchange in question upon expiry, although contracts can also be bought and sold before they expire. The forwards and futures markets can offer protection against risk when trading currencies. Usually, big international corporations use these markets in order to hedge against future exchange rate fluctuations, but speculators take part in these markets as well. (For a more in-depth introduction to futures, see Futures Fundamentals.)

Note that you'll see the terms: FX, forex, foreign-exchange market and currency market. These terms are synonymous and all refer to the forex market.