• Intervention


• Concerns about Eurocurrency

Despite the size and importance of the foreign exchange market, it remains largely unregulated. There is no international organization that supervises it, nor any institution that sets rules. However, since the advent of the flexible exchange rate system in 1973, governments and central banks, such as the Federal Reserve System in the United States, occasionally intervene to maintain stability in the FX market.

There is no standard definition of instability or a disorderly market—circumstance must be evaluated on a case-by-case basis. Sharp rapid fluctuations of exchange rates and traders’ reluctance to be ready to either buy or sell currencies (maintaining a "two-way" market) may be signs of disorderly market.

To restore stability, the central banks often work together. However, a country taking a conservative view on intervention would act only in response to unusual circumstances that require immediate action, like political unrest or natural disasters. Most monetary authorities would be less likely to intervene to counteract the fundamental forces that drive FX markets, such as trade patterns, interest rate differentials and capital flows.

The U.S. Treasury has the overall responsibility for managing the U.S. government’s foreign currency holdings. It works closely with the Federal Reserve to regulate the dollar’s position in the FX markets. If the Treasury feels that there is a need to weaken or strengthen the dollar, it instructs the Federal Reserve Bank of New York to intervene in the FX market as Treasury’s agent. The Federal Reserve uses the Exchange Stabilization Fund (ESF) to finance these interventions. Learn more about the ESF .

The Federal Reserve Bank of New York buys dollars and sells foreign currency to support the value of the dollar. The Fed also sells dollars and buys foreign currency to try and exert downward pressure on the price of the dollar.

The transactions in the intervention are small compared to the total volume of trading in the FX market and these actions do not shift the balance of supply and demand immediately. Instead, intervention is used as a device to signal a desired exchange rate movement and affect the behavior of investors in the FX market.

The frequency of intervention in the FX markets by the U.S. monetary authorities has reduced tremendously over the last decade. The Federal Reserve Bank of New York intervened only twice since 1995.

Central banks in other countries have similar concerns about their currencies and sometimes intervene in the FX markets as well. Usually, intervention operations are undertaken in coordination with other central banks.

Most of the Federal Reserve Bank of New York’s activities in the foreign exchange market are for far less dramatic purposes than to influence exchange rates. The New York Fed often intervenes in the FX market as an agent for other central banks and international organizations to execute transactions related to flows of international capital.

Learn more about the Federal Reserve Bank’s role in the FX market.

Some countries have special arrangements with other countries to help them keep their currencies stable. Many less developed countries have their soft currencies pegged to hard currencies, so their value rises and falls simultaneously with the stronger currency. Some peg, or target, their currency to a basket of hard currencies, the average of a group of selected currencies.

Countries that are part of the European Union (EU) had pegged their currencies to the euro. There were formulas set for converting from the euro to the currency of each member nation. However, since January 2002, all currencies that were part of the Economic and Monetary System of the EU ceased to exist.

Intervention in the FX market is not the only way monetary authorities can affect the value of their countries’ currencies. Central banks can also affect foreign exchange rates indirectly by influencing interest rates.

Eurocurrency, especially eurodollars (approximately two-thirds of Eurocurrency are U.S. dollars) are a source of concern to central banks and regulators because they are "stateless money"—subject to very little regulation. Rules governing currency and bank deposits— such as taxes, restrictions on capital movements and exchange controls—do not apply to the currency in the Eurocurrency markets.

Banks around the world use the Eurocurrency market to move and store funds more profitably than they could in many countries. This poses a problem for countries attempting to regulate capital flows.

International trade and foreign exchange cannot be viewed as two separate economic processes. The two are intimately connected on many levels. Increased trade and investment has brought the FX markets to their present level. Together, trade and foreign exchange affect peoples’ living standards and livelihoods all over the world.