Foreign Currency Definition

Currency is any generally accepted medium of exchange for goods and services in a particular country or region. Today currency normally takes the form of paper notes and coins. Foreign currency is any currency not normally used in a particular region or country. There are almost 200 currencies worldwide today. Although most countries have their own currency, there are some that adopt another country’s currency as their own. The euro is a common currency in a number of European countries.

Before there was money people would trade, or barter, goods directly—say a certain number of cows for a certain number of tools. This, however, became complicated as the number of goods and services traded grew. That's why a common currency was needed—to help people determine how many tools a cow was worth. Any durable commodity could be used as currency. Shells, furs, teeth, beaver pelts, dried corn or buckskin (hence the term "buck" for dollar). As Niall Ferguson writes in the "Ascent of Money," the earliest known coins date to 600 B.C. and were found in the Temple of Artemis at Ephesus in modern-day Turkey. First banknotes originated in seventh-century China.

As trade grew between nations that all had their own separate currencies, there was a need to establish foreign exchanges, where foreign currencies could be bought and sold. This came with the birth of the gold standard in 1875. Before that, precious metals such as gold and silver were used for international payments. Gold standard meant that any currency was backed by gold, measured in ounces. Countries were required to keep large reserves of gold to back the demand for currency. The price of an ounce of gold was set for each currency and the difference in price between two currencies became their exchange rate.

The gold standard was abolished with the outbreak of World War I in Europe and in July 1945 replaced by the Bretton Woods system, in which the U.S. dollar, as the only currency backed by gold, became the ultimate exchange currency. It was replaced in the early 1970s by the current system of floating exchange rates in which currencies are not tied to one another or to gold.

Whether you have an importing or exporting business, or simply plan to make a tourist trip abroad, there are a couple of important foreign currency considerations. Tourists should buy their foreign currency before they travel, which is usually a bit cheaper than buying it on arrival. For larger purchases or other expenses while abroad, it is better to use a credit card, since most credit card issuers use their own exchange rate, usually slightly lower then the rates abroad, when they bill you.

Businesses that buy or sell goods abroad can incur significant losses due to exchange rate fluctuations between the time of purchase and time of payment. They should talk to their bank about hedging against foreign currency rises.