market ’ s relative position was little changed, remaining the seventh largest market. there was more variation in growth rates by currency. among the major currencies, the canadian dollar and the australian dollar experienced the fastest growth, with turnover increasing 50 per cent and 40 per cent respectively. the australian dollar became the fifth most traded currency, overtaking the swiss franc in which growth was subdued. the aud / usd remains the fourth most traded currency pair. turnover involving the us dollar grew slightly less than the average. however, it still maintains its dominant role in foreign exchange markets, being involved in 85 per cent of all transactions. graph 1 while turnover in all instruments has grown over the past year, growth has been faster in spot and forward instruments than foreign exchange swaps ( graph 2 ). spot and forwards turnover has rebounded by 40 per cent since early 2009 and volumes are now above those seen in 2007. in contrast, turnover in swaps has grown by around 20 per cent over the past year and remains about 10 per cent below its peak. graph 2 this difference reflects the varied uses of these instruments. there is a strong correlation between growth in spot and forwards turnover and international trade. in these markets, trade has increased by more than 30 per cent since its trough in march 2009, driving the rebound in spot and forwards turnover ( graph 3 ). graph 3 the recovery in cross - border capital flows has also contributed to the pick - up in spot and forwards turnover. foreign banking flows, foreign direct investment and portfolio investment all contracted earlier and faster than international trade during the crisis. these capital flows have recovered of late, supporting spot and forwards turnover in 2010. however, the recovery in cross - border capital flows has been more muted than that in trade ; capital flows in g3 countries remain at much lower levels than seen prior to the crisis. these lower flows are likely to be part of the explanation for the slower growth in swaps turnover, which are more dependent on financial activity than are spot and forwards. along with the rebound in turnover, liquidity in the foreign exchange market has also improved. as i noted when i last addressed this forum, 1 liquidity and turnover, while related, are not necessarily the same thing. the bid - ask spread is one potential measure of liquidity and it shows the steady improvement in market conditions ( graph 4 ). the bid - ask spread widened appreciably in may of this year but the deterioration in conditions was short - lived and significantly

less than in late 2008. graph 4 see “ the australian foreign exchange market in the recovery ”, address to westpac forum, 10 december 2009. while turnover has recovered, the pricing of foreign exchange swaps has been affected by the events of the financial crisis in a more long - lasting way. historically, the implicit cost of borrowing us dollars through the swap market was the same as borrowing directly in the us dollar money market, that is, us dollar libor. covered interest parity held and there was no implicit basis in the foreign exchange swap market. however, during the crisis the basis in the swap market widened considerably implying a large premium for borrowing us dollars under swap ( graph 5 ) : the pricing indicated it was considerably cheaper to borrow us dollars directly in the interbank market than under swap. this basis has narrowed significantly from its peak in late 2008, but remains positive at around 50 basis points. graph 5 the origin of this positive basis is the dislocation in money markets that emerged through 2007 and 2008. 2 prior to the crisis, banks outside the united states – mostly in europe – built up large us dollar asset positions which were funded in part by rolling short - term us dollar borrowing. there was a large maturity mismatch between their short - term funding and their long - term asset positions. in the second half of 2007, the supply of us dollars in the money markets tightened considerably and these banks found it increasingly difficult to borrow the us dollars they needed directly. nor could they sell the assets because of their illiquidity. following the collapse of lehman brothers the situation worsened as general counterparty concerns saw the supply of us dollars in the unsecured money market largely disappear. in response, non - us banks increasingly sought to obtain us dollars via the foreign exchange swap market, but supply of us dollars here was also tight. this saw the basis spike sharply higher in october 2008. under normal conditions, market forces would ensure any price discrepancy would be arbitraged away. however, there were a number of constraints on the ability to arbitrage over this period. increased risk aversion, counterparty concerns and balance sheet losses restricted potential arbitrage activity. further, us institutions with access to us dollar borrowing tended to hold additional precautionary balances to ensure their own liquidity rather than lending in the market. for more analysis of this, see cgfs ( committee on the global financial system ) ( 2010 ), “