Page 54 - Ultimate Guide to Currency Trading

Examples of this would be the Caribbean Netherlands using the U.S. dollar, the Cook Islands using the
New Zealand dollar, and Liechtenstein using the Swiss franc.

This method allows the greatest stability to these economic centers, but the use of a
dollarization regime reduces the control of the central bank of these nations to next to nothing. They
are at the full will and whim of the assumed currency and all of the interest rates and money supply
growth and shrinkage that the assumed currency is assigned by those foreign central bankers. For all
of its downfalls, the system works for smaller countries or ones with near and direct ties to their
neighbors.

The Gold Standard and FX Trading

The third method is one called the floating rate system. This is the method of currency management
that you should be most concerned with while you are looking for good FX trades to develop. Before
you learn what is the floating rate system is, it would be best to go back about 150 years to the
development and usage of a different system, the gold standard.

The gold standard was a method of monetary management that was initially developed and
adopted by the Bank of England in the mid-1800s. This system was one in which a certain amount of
the face value of paper money could be directly exchanged with a certain amount of gold. The amount
of the paper money face value was essentially fixed to an amount of gold that was defined by weight
and fineness.

Countries all over the world issued gold coins. In some of these countries the gold coins were
only used to transfer wealth, not as a method of payment in everyday situations. There were, among
others, Netherlands 10 guildens, .1947 ounce gold; Belgian 20 francs, .1867 ounce gold; and India 15
rupees, .2354 ounce of gold. These different monies were directly convertible into each other by the
weight and fineness of each gold standard coin that the country issued.

In 1944, the world adopted an international gold standard that was based upon the
convertibility of the currencies of Europe into the U.S. dollar, which was then in turn pegged to a
certain weight and fineness of gold. The convertibility was simply $35 per ounce of .995+ fine gold.

The idea was simple. Instead of gold coins being circulated through-out Europe and the rest of
the world in trade, they could be melted down, formed into 400-ounce bars, and stored at various
vaults throughout the world. A home country would then issue paper money, and convert it into
dollars, and then convert those dollars into gold, resulting in a kind of U.S. dollar/gold standard.

Pre-1944 foreign gold coins continue to be bought and sold to this day. It is common for
investors to hedge stock, bond, and FX portfolios with a long gold position. These
investors often buy gold coins because the coins are usually sold at only a few dollars

above their gold value. This gold value is called a melt value.