The Top Five Forex Events of This Decade

In 2010, we are ringing in a new year and a new decade. Before we start thinking about what could come in the next year, however, we want to take this opportunity to talk about the five most memorable forex events of the past decade. The past ten years have been a rollercoaster ride for everyone. The highs include the birth of social networking, the growing popularity of Google, and the online video revolution led by YouTube and the debut of Apple’s iPod and iPhone products.

The lows include the financial crisis, 9/11, and natural disasters. These developments have affected each of our lives, but only a few have had a lasting impact on the currency markets. Here are the forex events that have made our top five list. We encourage all of our readers to add your own in the comments section, and if they are interesting, we may even collect them for an updated report!

1) Euro: Lives up to Expectations, Becomes a Global Currency

The euro was launched on January 1, 1999, but it did not come of age until the past decade. Initially, eleven countries joined together to launch the common currency, and now, the membership in the euro zone has expanded to 16 nations, with even more countries itching to join the club. A total of 23 countries that do not belong to the European Union have even pegged their currencies to the euro. When the currency was first launched, there was a lot of skepticism about whether a single European currency would last and whether the European Central Bank would be effective in balancing a monetary policy that would be suitable for all member nations. In fact, the skepticism was so intense that the EUR/USD plunged from its initial rate of 1.18 to a low of 0.8228 by October 26, 2000.

Fast forward a decade to the present and we now know that the EUR/USD has stood the test of time and proven to be one of the most successful financial experiments of the decade. Not only is the EUR/USD trading well above the level at which it launched, but it has also become the world’s second most actively traded currency after the US dollar. More importantly, the euro has become the second largest reserve currency, which means that central banks around the world have recognized that the euro is here to stay. The euro is already beginning to challenge the US dollar’s status as the world’s primary reserve currency, and it is an understatement to say that over the past ten years, the euro has come a long way, because in that time it has proven to be a smashing success.

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NEXT: The Rise and Fall of the Carry Trade

2) Carry Trade: Birth, Death, and Rebirth

For anyone trading currencies more than a few months, you have most likely come across the term “carry trade.” For those of you that have not, in simple terms, a carry trade involves buying a currency with a high interest rate and funding that purchase by simultaneously selling a currency with a low interest rate. In the forex market, this is easily achieved since currencies are quoted and traded in pairs. The goal is to earn higher net interest income and hopefully capture some capital appreciation along the way.

Carry trades were extremely popular throughout the past decade, particularly among retail investors. The reason is because it was a fairly straightforward trade that worked for nearly five years straight. Between the summer of 2002 and the summer of 2007, carry trades such as the Australian dollar/Japanese Yen currency pair appreciated more than 60%, while the differential between Australian and Japanese three-month LIBOR rates increased 16%. During this trade, anyone long AUD/JPY would have captured both the interest income and the capital appreciation. However, the carry trade died a painful death in August 2008 when the financial crisis hit, causing currency pairs like AUD/JPY to give up five years worth of appreciation in as little three months.

For six months after that, carry traders were afraid to come back into the markets, but now that the financial markets have stabilized, we are beginning to see the rebirth of carry trades. As long as there is not another shock and central banks start to raise interest rates next year, the carry trade should continue to recover.

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NEXT: China Emerges as a Global Economic Power

3) China Emerges as World Economic Power, Pulls the World out of Recession

The rise of China has been one of the biggest economic stories of this decade. The gross domestic product of China has increased more than 200% over the past ten years, rising from nine trillion yuan in 2000 to 30 trillion yuan in 2008. Over this time, China’s average GDP growth has been greater than 10%, helping the country become the world’s third largest economy by GDP. In just a few years, China is expected to overtake Japan as the world’s second largest economy. In that same time, China has also become the world’s largest holder of foreign exchange reserves, which is why the nation is extremely important to the foreign exchange market.

Although there are no clear statistics, it is estimated that more than half of their reserves are held in US dollars and that they own close to 25% of all US Treasuries held by foreigners. China has turned itself into America’s largest creditor, which means that they have tremendous economic leverage on the US economy. One of the biggest threats to the dollar and the US economy would be a massive sale of US treasuries by the Chinese central bank. Imagine if someone came into the foreign exchange market and sold a billion dollars, let alone any meaningful portion of China’s $798.9 billion investment in US dollars. Even talk of this has hurt the dollar, not only because of the foreign exchange impact that such a sale would have, but also because it would drive Treasury yields sharply higher. For this reason, the US is affected by China just as much as China is affected by the US—the two countries have become mutually dependent. On a brighter note, China’s decision to move to a floating exchange rate system that references a basket of currencies has increased their demand for currencies outside of the US dollar.

If China were ever to free float their currency, the impact on the foreign exchange could be even more dramatic, as it would reduce their need for US dollars and pave the way for the rise of the Chinese yuan as a new reserve currency. More recently, China has proven its importance by effectively pulling the world out of recession. As a percentage of GDP, the Chinese government’s massive stimulus package is the largest in the world, and the results show that their stimulus package has helped to stabilize their economy as well as the Asia region as a whole. In fact, many countries in and out of the Asia Pacific region have openly credited their recovery to the recovery in China. Over the next few years, we expect Chinese imports to become just as important as Chinese exports, increasing China’s influence on the world.

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NEXT: The Great Recession Strikes

4. The Great Recession Triggers Record-Breaking Moves

One of the most defining events of this past decade is fresh in the minds of many investors because the world is still recovering from the greatest economic crisis in modern history. The crash of 2008 sent the Dow tumbling 40% between October 2008 and March 2009. Who can forget the day in September 2008 when the Dow closed down nearly 778 points, the largest single day decline ever? The subprime/banking/global economic crisis wiped out IRA and retirement funds, triggered massive layoffs in the US and abroad, pushed many countries into recession, forced central banks to slash interest rates to record lows, and governments around the world to open their pocketbooks and spend their way out of recession.

Unlike previous recessions, the severity of the latest recession has caused the demise of decade-old institutions and families who have built their wealth over many decades. The global financial crisis also triggered a massive wave of deleveraging that pushed investors into the safety of the US dollar and Japanese yen. Between October and March, the dollar appreciated more than 10%, and if we include the appreciation in the second quarter, the dollar strengthened more than 23%. High-yielding currencies of countries that are particularly sensitive to export demand plummeted in the process. However, thanks to the trillions of dollars those countries have spent on stimulating their economies, the worst is behind us. The global financial markets have stabilized and many countries have started to grow again. Yet the consequence of the being white knights is long-run fiscal sustainability. Countries like Greece have already come under the chopping block. Even though the US and the UK are not vulnerable to a credit downgrade, there is a lot of fear that the rest of world may be unwilling to finance the burgeoning deficits.

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NEXT: The Birth of Retail Forex Trading

5. Forex Trading Explodes

What has affected currency traders the most over this past decade is the birth of retail forex trading. Ten years ago, forex trading was limited primarily to banks, institutional investors, hedge funds, governments, and wealthy individuals. However, the popularity of the Internet has dramatically changed how retail investors access the foreign exchange market. According to the Bank of International Settlement’s triennial forex report, trading volume in the foreign exchange market has doubled in the past ten years. As of 2007, daily turnover exceeded US$3.2 trillion, and the latest poll from Euromoney suggests that volumes increased another 41% between 2007 and 2008. Retail foreign exchange traders have played a big role in the higher trading volumes and the growing popularity of the industry. As a result of increasing demand, transaction costs such as spreads have decreased, technology offerings have improved, and value-added services have exploded.

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As we look ahead to the New Year, we want to recognize the contribution that technology has made to economic growth over the past decade, and we hope that another new industry will arise, helping to transform the world and fuel growth for decades to come.

By Kathy Lien of GFTForex.com