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1. DEFINITION OF CURRENCY Currency refers to a generally accepted medium of exchange.

These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply. The other part of a nation's money supply consists of: 1. bank deposits (sometimes called deposit money) 2. ownership of which can be transferred by means of cheques, debit cards, or other forms of money transfer 3. Deposit money and currency are money in the sense that both are acceptable as a means of payment. All contemporary money systems are based on fiat money modern currency has value only by government order (fiat). Usually, the government declares the fiat currency (typically notes and coins issued by the central bank) to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts, public and private. In most cases, a central bank has monopoly control over emission 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. History of currency 1. Early currency 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. This first stage of currency, where metals were used to represent stored value, and symbols to represent commodities, formed the basis of trade in the Fertile Crescent for over 1500 years.

2. Coinage era Metals (silver, gold, copper,or silver-gold) 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. 3. Paper money In premodern China, the need for credit and for circulating a medium that was less of a burden than exchanging thousands of copper coins led to the introduction of paper money, commonly known today as banknotes. The advantages of paper currency were numerous: it reduced transport of gold and silver, and thus lowered the risks; it made loaning gold or silver at interest easier, since the specie (gold or silver) never left the possession of the lender until someone else redeemed the note; and it allowed for 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. However, these advantages held within them disadvantages. First, since a note has no intrinsic value, there was nothing to stop issuing authorities from printing more of it than they had specie to back it with. Second, because it increased the money supply, it increased inflationary pressures, a fact observed by David Hume in the 18th century. The result is that 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.

2. KINDS OF CURRENCY SYSTEM a. Floating Exchange Currency A currency whose value is determined by the free market. That is, the value of a floating currency changes constantly depending on the supply and demand for that currency, as

well as the amount of the currency held in foreign reserves. An advantage to a floating currency is that it tends to be more economically efficient. However, floating exchange rates tend to be more volatile depending on the particular currency. A floating currency may undergo currency appreciation or currency depreciation, depending on market fluctuations. Most major currencies are floating currencies.

b. Fixed Exchange Currency A fixed exchange rate is based upon the governments view of the value of its currency as well as the monetary policy. It has advantages that is stability. Sometimes

government decide to link the value currency with another goods for example gold. For example, under the Bretton Woods System, most world currencies fixed themselves to the U.S. dollar, which in turn fixed itself to gold. Importantly, fixed exchange rates do not change according to market conditions. It is also called a pegged exchange rate.

3. CURRENCY CONTROLER In cases where a country does have control of its own currency, that control is exercised either by a central bank or by a Ministry of Finance. In either case, the institution that has control of monetary policy is referred to as the monetary authority. Just like other central banks, Bank Indonesia has the authority to carry out foreign currency intervention at both policy and operational levels. Internal Bank Indonesia guidelines and regulations that guide and constrain foreign currency intervention emphasize efficient implementation, taking into account factors such as market liquidity conditions, transaction turnover, and market psychology. Central banks of a county or region, like the U.S. Federal Reserve, seek to minimize the impact of currency fluctuations. The foreign currency exchange market functions as a tool for central banks to control the value of their currency by buying or selling currency, which influences the total amount in worldwide circulation.

The role of central bank: 1. Central Banks Set Interest Rates Central banks want to achieve financial stability of their currency (i.e. battle inflation) and maintain overall economic growth in their country. Their primary responsibility is to oversee the monetary policy of a particular country or group of countries (in the case of the European Union). Monetary policy refers to the various efforts made to effectively control and manage the amount of money circulating within a nation. 2. Central Banks Role in Fighting Inflation Inflation refers to a rise in price levels which causes a fall in the purchasing power of a currency.

4. CURRENCY FLUCTUATION A market-based exchange rate will change whenever the values of either of the two component currencies change. Currency fluctuation is simply the ongoing changes between the relative values of the currency issued by one country when compared to a different currency. a. Exchange rate. b. Supply and demand. A currency tendencies to become more valuable whenever demand for its is greater than the available supply. It will become less valuable whenever demand is less than available supply. The laws of supply and demand shows that:
a. b. c. d.

High supply causes low prices, and high demand causes high prices. When there is an abundant supply of a given commodity then the price should fall. When there is a scarce supply of a given commodity then the price should increase. Therefore, an increase in the demand for a commodity would cause it to appreciate in value, whereas an increase in supply would cause it to depreciate.

c. Increase transaction demand of money will make the currency stronger. The transaction demand of money is highly correlated to the countrys level of business activity, gross domestic product, and employment level d. The position of interest rate also affects the level of currency. The higher the rate interest of a country, the greater demand for that currency e. Current state of the economy of the country. In choosing what type of assets to holds people also concerned that the assets will retains its value in the future. A currency will tend to lose value relative to other currency of the the countrys level of inflation is higher, if the countrys level of output is expected to decline, or if the country is troubled by political uncertainty. f. Shock and speculation of the market. Exchange rate are move quickly in responses to surprise. Currencies are also trade as speculative investment so there are a lot of people gambling by speculate the movement of the exchange rate. g. Political issue may also impact the nature of currency changes. For example at the new of government may temporally diminish the value of the nation s currency on the open market. Once confidence is resorted the currency will tend to rise and the investors can consider the currency to be a worthwhile investment once again. 5. FOREIGN EXCHANGE MARKET The Foreign Exchange Market is the financial market in which currencies are bought and sold that is a transaction is entered into where a given amount of currency is exchanged for another amount of currency. The focus of foreign currency exchange is the facilitation of international commerce. The primary function of foreign currency exchange markets is to convert the currency of one country into another country. Foreign currency exchange markets serve to facilitate international financial transaction. The amount of currency converted depends on the exchange rate which can be fixed or can fluctuate.

The need for the Foreign Exchange Market (commonly referred to as the Forex Market) developed to facilitate International trade where currencies were required to be settled from the country of both the importer and the exporter, determines the relative values of different currencies, and assists international trade and investment by enabling currency conversion. It therefore plays an extremely important role in facilitating crossborder trade, financial transactions and investment. There are major FOREX that exist in this market. They are often trade because they represent countries with esteemed central bank, stable governments, and relatively low inflation rates. They are: 1. U.S. Dollar ($), 2. European Currency Unit (), 3. Japanese Yen (), 4. British Pound Sterling (), 5. Swiss Franc (Sf), Canadian Dollar (Can$), Based on journal entitled Vehicle Currency use in International trade(January, 2005) analysis of this data reveals other more nuanced patterns in the use of the dollar as a vehicle currency in international transactions. Within the few countries for which industry details on invoicing are available, we observe substantial cross-industry variation in the extent to which the dollar is a vehicle currency on trade. The data show the dollar use as a vehicle currency in country trade with non-U.S counterparties is tightly correlated with the prevalence in a countrys exports or imports of transactions in the (Walrasian) organized exchange-traded and reference priced goods. Absent large macroeconomic shocks that could potentially disturb this established vehicle currency equilibrium, the prevalence of the dollar as a worldwide vehicle currency may be tied to the share of homogeneous goods in world trade and to the share of the U.S. as a direct counterparty in international trade transactions. As broad characterizations, we confirm that the U.S. dollar is the primary, but not unique, invoice currency choice in transactions involving the United States as

counterparty. The euro has replaced the legacy currencies in euro-area transactions and has displaced the dollar mainly in some transactions of European Union accession countries (ECB 2003). The dollar remains an important invoicing currency in transactions involving Asian countries, Australia, and the United Kingdom, among others.

In Indonesia, based on KEPUTUSAN MENTERI KEUANGAN REPUBLIK INDONESIA NOMOR: 155/KM.1/2012 TENTANG NILAI KURS SEBAGAI DASAR PELUNASAN BEA MASUK, PAJAK PERTAMBAHAN NILAI BARABG DAN JASA ATAS BARANG MEWAH, PAJAK EKSPOR, DAN PAJAK PENGHASILAN YANG BERLAKU UNTUK TANGGAL 20 FEBRUARI 2012 SAMPAI DENGAN 26 FEBRUARI 2012 stated in point two

Pasal 2 Dalam hal kurs valuta asing lainnya tidak tercantum dalam Pasal 1, maka nilai kurs yang digunakan sebagai dasar pelunasan adalah kurs spot harian valuta asing yang bersangkutan di pasar internasional terhadap dolar Amerika Serikat yang berlaku pada penutupan hari kerja sebelumnya dan dikalikan kurs rupiah terhadap dolar Amerika Serikat sebagaimana ditetapkan dalam Keputusan Menteri Keuangan ini.

There a close relationship exists between monetary policy and international trade. Domestic monetary stimulus can enhance export opportunities for trading partners, just as contractionary policy can reduce them. Foreign exchange controls for balance of payments purposes can impede exports. The use of a specific currency in invoicing international trade transactions can now be broader than the importance of that currencys home country as a direct counterparty in international trade transactions. With prices in the market set in different currencies, exchange rate fluctuations will affect the price of the firms goods relative to that of its competitors, leading to fluctuations in the quantities sold.

In which currency should exporters set the price of their goods? When selling to a foreign market, an exporting firm has three options. It can invoice the transaction in its own currency (producers currency pricing, PCP), in the currency of the destination country (local currency pricing, LCP), in a third currency (vehicle currency pricing, VCP), or in a combination of these.

6. EXCHANGE RATE In order to facilitate trade between these currency zones, there are different exchange rates, which are the prices at which currencies (and the goods and services of individual currency zones) can be exchanged against each other. So exchange rates comes in pairs, where one countrys currency is measured against another countrys. The buying rate is the rate at which money dealers will buy foreign currency, and the selling rate is the rate at which they will sell the currency. An exchange rate refers to the ratio at which the unit of currency of one country may be, or is, exchanged for the unit of currency of another country. It is the price of one countrys currency expressed in terms of another countrys currency. Each currency has a code by which it is identified. Each code consists of three letters the first two letters identify the country and the 3rd letter is the first letter of the name of the currency. For example Indonesia =ID, rupiah = R thus the currency = IDR. An exchange rate is a two-way interpretation that is the price of currency A (for example USD) in terms of currency B (for example rupiah/ IDR). For example, an exchange rate of USD1 = IDR9091 can be interpreted that it will cost you IDR9091 to buy 1 USD, or alternatively, for 1 USD you will receive IDR9091 Because foreign exchange transactions involve the exchange of one currency for another, the exchange rate itself is determined by the conditions surrounding demand and supply for the relevant currencies. The following factors influence exchange rate fluctuations:

1. Balance of Payments (BOP) A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency.

This is just another economic indicator of a country's relative value and, along with all other indicators, should be used with caution. The BOP includes the trade balance, foreign investments and investments by foreigners. 2. Interest Rates An increased in interest rates encourages traders to invest within the market and caused the demand for the currency to rise. As demand rises, the currency becomes scarcer and consequently more valuable. A fall in interest rates dissuades investors from purchasing assets in that economy, as the return on their investment is now smaller. 3. Political developments 4. Government policy 5. Speculation 6. Market sentiment 7. Foreign investment flows 8. Bank

The participants of the Foreign Exchange Market are: 1. Companies that export and import 2. Foreign investor and commercial Banks 3. Speculators who wish to engage in market activity 4. Money brokers 5. Corporations 6. Traders

REFERENCES

Vehicle Currency Use in International Trade. Linda S. Goldberg and Cdric Tille. Staff Report no. 200. January 2005

International Trade and Currency Exchange.Hlne Rey and Princeton University and CEPR. May 1999

Foreign Exchange Market Journal by The Standard Bank of South Africa Limited 2009

"CURRENCY MANIPULATION" AND WORLD TRADE. Robert W. Staiger and Alan O. Sykes. National Bureau of Economic Research. 1050 Massachusetts Avenue. December 2008

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