Global Trade Center

Growth of the Market
The foreign exchange market expanded rapidly with the breakdown of the Bretton Woods system of fixed exchange rates in 1971 and exploded with the large increase in exchange rate volatility that began in the late 1970s. In 1977 trading volume in New York amounted to less than $5 billion a day (about $15 billion in 1998 dollars). By 1998 it had increased to $351 billion a day. Trading volume in London, the center of the world market for foreign exchange, was $637 billion a day in 1998, and the worldwide total was about $1.5 trillion a day. By 2001, total trading volume had fallen to $1.1 trillion. One reason for this was the creation of the Euro, which replaced 11 national currencies. Another reason has been the consolidation of the banking industry, which has reduced the number of participants in the market.
Trading volume in foreign exchange is nonetheless many times greater than the volume of international trade. In fact, most foreign exchange transactions are related not to trade but to finance. For example, if a Japanese pension fund wants to buy U.S. government securities, it must change its yen into dollars. Indeed, as the volume of international financial transactions has grown, securities firms have increasingly become dealers in foreign exchange, offering this service to their customers themselves, rather than referring them to a commercial bank.

Why Payment Patterns Differ
Payments patterns differ across countries for a variety of reasons-legal, historical, and economic.

Some Legal and Historical Reasons. Some countries use checks and others use giro payments for reasons that lie mainly in their legal histories. The check evolved in the English-speaking countries. English courts viewed it as a variety of commercial bill of exchange. 21 The early recognition by English courts of the negotiability of commercial bills, and so of checks, made their use much easier. If a check is negotiable, you can sign it over to your bank, and your bank can collect payment through the clearing system. If a check not negotiable, clearing becomes impossible and you yourself must present each check for a payment at the payer’s bank.

European courts did not regard the check as a variety of commercial bill, but rather as a variety of personal order of payment. The personal order of payment goes back to the medieval money-changer banks that we learned about in Chapter 6. These banks allowed their customers to make payments by transferring ownership of deposits. Initially, orders to transfer deposits were made orally, and they required the physical presence of all the parties involved-the payer, the payee, and the banker. The courts recognized transfers performed in this way as constituting a final discharge of a debt. The money changers had a rudimentary clearing system: transfers were cleared between banks by means of reciprocal clearing accounts that the banks held with one another.

The most familiar way to transfer ownership of deposits is by check. For example, suppose you have a deposit with First National, and you wish to pay Videomax $700 for a new TV. That is, you need to transfer ownership of 700 of your bank dollars to Videomax. You do this by writing Videomax a check for $700. Note that the check itself is not money: it is merely an order to pay money. It is an order from you to First National to transfer $700 of your deposit at the bank to Videomax.

If Videomax has a deposit at First National., it can present your check to the bank, and $700 dollars will be transferred from your deposit to Videomax’s. First National. will now owe you $700 less and Videomax $700 more. Payment has been completed. You have made payment in bank dollars of First National Bank and Videomax Has received payment in the same.

Suppose, though, that Videomax has its deposit at a different bank, Metrobank. Videomax will then have no use for the bank dollars of First National Bank. It will need to convert the $700 into bank dollars of Metrobank.

One way Videomax Can do this is to send a messenger to First National to present your check for immediate payment in cash. The cash can then be taken to Metrobank for deposit (conversion into Metrobank dollars). This method is quick and simple but inconvenient, and it is worthwhile only for large sums of money.

The more usual procedure is for Videomax to delegate collection of the check to its own bank. Videomax signs over the check (endorses it) to Metrobank, converting it into an order to pay Metrobank. Metrobank collects payment from First National and credits Videomax’s deposit with $700.

In this way, Videomax gets the Metrobank dollars it want. In exchange Metrobank gets $700 in First National dollars. If Metrobank finds it useful to maintain a deposit at First National, it may keep the $700 in this form. Or Metrobank may demand conversion of the First National dollars into definitive money