A Trader’s Primer of the History of the Forex ( FX or Foreign Exchange ) Market
Through most of history, the value of goods was percieved in terms of other goods. We had an economy based on the barter system, two products of a similar value. There were however, limitations to this kind of system which encouraged the establishment of a more general system of economics fairly early in human history, setting a common pricing regimen of value. In different cultures and economies, everything served this purpose from shiny stones, to teeth. But soon, metals, in particular gold and silver, established their place as an accepted means of payment as well as an easy unit of storage.
At first, coins were simply minted from the chosen metal, but in a stable political situation, the introduction of a paper form of government IOU gained wide acceptance during the Middle Ages and later. These IOU’s were more often than not, introduced through the use of force, than persuasion. Such was the start of the modern currency as we understand it.
Before the First World War, central banks backed their currencies with gold. Paper money could always be exchanged with gold in theory, but the reality was that this didn’t occur very often. This led to the dubious belief that there was not necessarily a need for the governments to fully cover the amount of paper currencies in their central reserves.
There were times when the bloating supply of paper money (much as is happening in 2009), held without sufficient gold cover led to disasterous inflation, resulting in political instability. To protect national interests, foreign exchange controls were introduced more and more often in order to stop market forces from punishing fiscal irresponsibility.
Late in WWII, the Bretton Woods agreement was reached at the initiave of the USA in July 1944. The Bretton Woods conference rejected John Maynard Keynes’ suggestion which would have created a new reserve world currency in opposition to the system based on the US Dollar. At the same time, other international institutions such as the World Bank, The IMF and GATT (General Agreement on Tarriffs and Trade), the winners hoping to avoid the destabilising monetary crises that had led to start of the war.
Bretton Woods resulted in a system of fixed exchange rates which partially reinstated the gold standard. It fixed the value of the USD at $35/oz and fixed the other main world-wide currencies to the dollar, and it was intended to be the permanent state of affairs.
All thing being equal, this would have been a stable state of affairs which would have worked. However, things are NOT equal between the worlds economies and powers and as a result, the system came increasingly under pressure as national interests and priorities took precedence. From time to time the signatories to the agreement realigned the parameters of the agreement, hoping for stability, but eventually the agreement collapsed in the early seventies after President Nixon suspended US gold converability in August of 1971.
Under sustained pressure from increasing Trade Deficits and Budget Deficits, the US dollar was no longer a suitable vehicle as the only international currency. As a consequence, each currency has it’s own value, the marketplace setting that value and THAT is the heart of the foreign exchange ( or Forex or FX ) markets as we know them in the 21st century.
The decades since the collapse of Bretton Woods have seen forex or fx trading and its traders grow into the largest global marketplace, by FAR. Artificial restrictions on market caps have been for the most part removed, allowing the market to set the percieved values of foreign exchange rates.
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