The Institution of Foreign Exchange Trading

Abstract

The volume of literature produced by economists on the subject of foreign exchange rates is massive. Unfortunately, this work yields few broad-based conclusions about the operation of tbe foreign exchange market. Theories abound that purport to explain rate movements in terms of the monetary or portfolio models, or in the context of news or rational expectations. But when those theories are compared to actual events in the foreign currency market, it quickly becomes clear that no one can confidently say that they reflect reality. Much of the problem with the existing models is their treatment of the institution of the market. Each model is based on the assumption that studying a market is much like studying fission or fusion. Markets are perceived to be quasi-physical phenomena, composed of a system of deterministic laws leading to predictable outcomes. But markets, like democracy and marriage, are social institutions, not physical phenomena such as light waves or friction. They serve to organize and guide human behavior through sanctions (formal and informal, negative and positive), mores, norms, status, and shared worldviews. Activities of markets are the activities of people and societies. Surely, a study of the foreign exchange market based on this premise would be more productive than what has already been conducted in this area.

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