After the abolition of the gold standard, many countries began to look for ways to minimize currency risks. But, as practice has shown, the currency basket turned out to be the most reliable tool for ensuring the security of the national currency and controlling the dynamics of its exchange rate. We have not yet talked about this economic instrument. Therefore, today we will try to fill this gap and get acquainted with the currency basket, its contents and scope.

CURRENCY BASKET IS AN EFFECTIVE TOOL FOR ASSESSING THE VALUE OF CURRENCY

Before talking about the currency basket, you need to define what is meant by this term. In economic theory, it is generally accepted that a currency basket is an arbitrarily formed set of several names of foreign currencies, the weighted average value of which is used to determine the value of a government obligation (debt) or the value of the national monetary unit.

The volume of currency included in the basket is determined by its specific gravity, which may depend on the following indicators:

• The value of the country’s gross domestic product and its share in the total gross product of the countries whose currencies form a specific currency basket.
• The parts dealing with foreign exchange in all international settlements and foreign trade transactions.

What is a currency basket in simple words?

Let’s assume that a country that has issued its own currency wants to objectively assess its value. Moreover, most contracts and international obligations are invested in euros, American dollars and British pounds. Therefore, the state can set the price of a currency as the cost of a basket, which includes (in a certain proportion) euros, dollars and pounds. This will make it possible to obtain an objective estimated value of the national currency in all international payments.

Practical use of the currency basket

In modern conditions, the currency basket can be used:

• Issuing countries in their monetary policy.
• Large financial structures and organizations working in the field of international lending.
• Enterprises and individuals to protect existing funds from negative exchange rate fluctuations.

Depending on the filling, the basket can be:

• Multicurrency, which is filled with an unlimited number of different currencies.
• Dual currency, formed from two types of currencies.
• The multi-currency basket option is more common because it allows parties to take into account both their own risks and the risks of their trading partners. In addition, when forming a multi-currency basket, additional opportunities for earnings or hedging open up that currency traders and investors can take advantage of.

As for the concept of “dual-currency basket,” the most striking example is the currency basket of the Bank of Russia, which was used until 2014. It consisted of two currencies: the euro and the US dollar. A special feature of the functionality of this basket was that it made it possible to systematically monitor the dynamics of the ruble exchange rate. It was not a separate exchange rate to the dollar or euro that was taken into account, but a generalized indicator with the share of each foreign currency was calculated. The presence of such an indicator allowed the country’s monetary authorities to reasonably adjust the exchange rate of the national currency. Since 2014, the ruble exchange rate has become floating, and the Bank of the Russian Federation basket has lost its original value

Basket of currencies in the practice of international monetary relations

At the interstate level, the currency basket is also widely used. An example of its practical use is the Special Drawing Rights (SDR), developed by the IMF in 1969. This artificially created payment instrument is used only within the framework of the International Monetary Fund. It allows:

• Regulate the balance of payments of IMF member countries.
• Replenish reserves and pay off loans provided by the Monetary Fund.

The SDR basket consists of the currencies of five countries:

• USA (dollar).
• European Alliance (euro).
• Japan (yen).
• UK (pound).
• China (yuan).

However, the cost of the entire basket is expressed in US dollars. The other components included in the basket are given continually adjusted weighting.

Another example of the use of a currency basket is the special European Currency Unit (ECU). It has all the characteristics of a basket of currencies and has been used in the European Union for:

Implementation of non-cash transactions between countries.

Regulation of parities of state currencies with the aim of creating a single European currency.

Once the euro has been issued, this currency can no longer be identified with the ECU, since the basket of currencies is created in the form of a portfolio of several different from the base one.

Currency basket and currency index

Traders working in financial markets often confuse the concept of a currency basket and a currency index. This is due to the fact that working with a basket of currencies is similar in content to portfolio investments (a trading operation with several assets to reduce the risk component associated with exchange rate fluctuations).

A basket can consist of a set of different currency pairs. It is not necessary to have a specific base currency.

If we are talking about indices, then they must demonstrate the general trend for a specific currency.

An example would be the dollar index. It shows the ratio of the value of the US currency to the value of a basket of major currencies. The code of such an index is purchased, which actually opens a long position in currency pairs where the dollar is the base currency and a short position in those pairs where the dollar is the quote currency. In this case, it is obvious that it is incorrect to talk about trading a basket.

Selling the dollar index would mean buying the basket of currencies included in the index. But this is only a special case, on the basis of which it is unacceptable to talk about the identity of the concepts “currency basket” and “currency index”.

Currency basket in the Forex market

When used skillfully, the currency basket provides great opportunities for traders trading on the Forex currency market. Having such a basket allows you to:

• Diversify risks when making trade transactions. Working with one currency does not allow you to do this. When creating a basket of currencies and working with it, this opportunity appears.
• Determine the weight of a particular asset and their impact on the dynamics of currencies forming a pair with it.
• Group currency pairs whose behavioral characteristics are important. Such signs include the relationship between the price of petroleum products and the exchange rate, the correlation between currency pairs, etc.
• Create an effective trading strategy that allows you to conduct transactions not with one asset, but with several. This achieves not only the profitability of currency trading, but also reduces the risk component.

From all that has been said, we can conclude that in conditions of instability of exchange rates of individual currencies, the presence of a currency basket is a necessity. At the state level, with its help it is possible to achieve a significant reduction in currency risks and validity in international payments. Regular traders can also take advantage of the benefits provided by currency baskets. By forming such a basket, they can significantly improve the quality of their trading in the financial markets.