Capital Flows and the FX Market

How the foreign exchange market works and who trades in it, how exchange rates are quoted, how to compute and read percentage changes, the difference between nominal and real exchange rates, the menu of exchange rate regimes from dollarization to free floating, why trade balances and capital flows mirror each other, and why governments sometimes restrict capital flows.

1. 1. The FX market: functions and participantsThe FX market is the world's largest market because almost every cross-border trade or investment has to pass through it, and most of its volume comes from investors and traders rather than importers and exporters.Free13 min
2. 2. Reading exchange rate quotesAn exchange rate A/B tells you how many units of the price currency A buy one unit of the base currency B, and every quote, bid and offer is about buying or selling that base currency.13 min
3. 3. Percentage changes in exchange ratesThe percentage change in A/B measures the base currency's appreciation or depreciation; the other currency's move is found by inverting the quote and is never the same size.11 min
4. 4. Nominal and real exchange ratesThe real exchange rate adjusts the nominal rate for price levels at home and abroad, so it measures what your money actually buys of foreign goods: the higher it is, the lower your relative purchasing power.Video · 5 min13 min
5. 5. Why no currency regime is idealNo country can have credibly fixed exchange rates, full convertibility and independent monetary policy all at once, and the history of currency systems is a series of choices between those goals.12 min
6. 6. The menu of exchange rate regimesRegimes run from giving up your own currency, through currency boards, pegs, zones and crawls, to managed and free floats, and each step toward flexibility buys monetary freedom at the cost of exchange rate stability.15 min
7. 7. Exchange rates, the trade balance and capital flowsA trade deficit must be financed by an equal capital inflow, so anything that moves the trade balance moves capital flows by the same amount, and in the short run it is capital flows that drive exchange rates.11 min
8. 8. Capital restrictionsFree capital flows usually raise welfare, but governments restrict them to protect strategic industries, stop capital flight in a crisis, or regain monetary control under a fixed rate, accepting administrative costs and damage to investor confidence.12 min
9. 9. Integrated cases: reading an FX and capital-flow briefA currency brief combines survey shares, a list of regimes, a saving-investment table and a capital-restriction rule; each part is read with a fixed method and the pieces then explain one another.15 min