History Of Foreign Exchange Market (Forex)
Today’s foreign exchange market (also known as “Forex” or “FX”) originated in 1973. However, currency in some form or another has circulated and has been in use since the time of Pharaoh.
The Babylonians are credited with the first use of paper bills and receipts. Middle eastern money changers were the first true currency traders, exchanging coins of one culture for another. During the Middle Ages, paper bills representing transferable third party payments of funds replaced coins as a currency of choice. This development made foreign exchange much easier for merchants and traders and played a central role in helping the regional economies to flourish.
From the middle ages, through the First World War, the currency markets were relatively stable and without much speculative activity. After WWI, however, the Forex markets became very volatile, and speculative activity increased tenfold. Initially, neither most financial institutions nor the public in general looked favorably upon currency speculation . The great depression and the removal of the gold standard in 1931 created a serious lull in Forex activity. From 1931 until 1973, the Forex market underwent a series of changes that greatly impacted the global economy during this period. There was very little , if any, speculation in the Forex markets during this time frame.
The Forex market’s first major transformation resulted the from the Breton Wood Accord, which occurred toward the end of world War II. The United States, Great Britain, and France met at the United Nation’s Monetary and Financial conference in Breton Woods New Hampshire to design a new economic order. The US was selected as the site of this historic meeting since, at the time, it was the only country unscathed by war, most European countries, by contrast, were in shambles. Till WWII, the British Pound had been the major standard by which most other world currencies were compared. This changed when the Nazi campaign against Britain included a major counterfeiting effort against its currency. Indeed, WWII vaulted the US DOLLAR from second tier currency after the stock market crash of 1929 to the world’s currency benchmark. The Breton Woods Accord sought to create a stable environment by which the global economy and leading nations could regain their footing. The Breton Woods Accord resulted in the pegging of currencies to the U.S dollar and established the International Monetary Fund (“IMf”) in hopes of stabilizing the global economic situation.
After Breton Woods Accord, major world currencies were pegged to the U.S Dollar and were allowed to fluctuate only by one percent to either side of the set standard. When a currency’s exchange rate would approach the limit on either side of this standard, the respective central bank would intervene, thus bringing the exchange rate back into the accepted range. In addition, the U.S Dollar was pegged to gold at a price of $35 per ounce. Tying the Dollar to Gold and the pegging of the other currencies to the U.S Dollar succeeded in bringing stability to the global Forex market.
The Breton Woods Accord lasted until 1971. Ultimately, it failed for a variety of reasons, but there can be no doubt that it did serve its intended purpose, which was to reestablish economic stability in Europe and Japan. After the Breton Woods Accords came the Smithsonian Agreement in December, 1971. This agreement was similar to the Breton Woods Accord but allowed for greater fluctuation bands for world’s currencies. In 1972, the European community tried to move away from its dependency on Dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium and Luxembourg. Both agreements were plugged by shortcomings reminiscent of those in the Breton Woods Accord and, by 1973, collapsed. The collapse of the Smithsonian agreement and the European Join Float signified the official switch to the free floating system. This occurred by default as there were no new agreement to take their place. Governments were now free to peg their currencies to the Dollar, semi-peg them, or allow them to freely float. In 1978, the free floating system was officially mandated.Europe attempted once more to gain independence from the Dollar in July of 1978, by creating the European Monetary System. This like of all the earlier agreements, failed in 1993.
Today the vast majority of major world currencies move independently of one another and are actively traded for speculative purpose by banks, hedge fund, brokerage houses, and individuals. Central Banks do continue to intervene on occasion to move or attempt to move currencies to desired levels. The underlying factor driving today’s Forex markets, however, is the basic, ongoing balancing act between supply and demand. The free floating system is ideal for today’s markets. Will the free floating system withstand the test of time? will the Dollar remain the dominant currency used in international trade and finance, or will the Euro ascend to this position? Will we see the day when individual investors routinely buy and sell currencies just as they do stocks and mutual funds? Only time will tell. But one thing’s for certain: The Forex Market is gaining popularity among online, self directed traders at rapid rate, because the advantages are so compelling.