History of the Forex Markets
The beginning of Forex market history can be traced back centuries ago to the appearance of the first currency traders. And considering that money has been around since the era of the Pharaohs, it could theoretically be traced even further back. However, the Forex Market as we know it today came into being in 1971 with the establishment of the first foreign exchange market and the appearance of floating exchange rates.
First Currency Traders
Currency traders first appeared in the Middle East. They used to exchange coins from one ethnic group to another. The need for another form of currency, besides coins, emerged during the Middle Ages and was implemented as an alternative method. According to historical records, the Babylonians were the first to use paper bills and receipts.
Paper bills were used as third-party transferable payments of funds. This method was more conducive to forex trading and considerably facilitated the work of merchants and other traders. It also helped bolster local economies.
In the Middle Ages, forex markets were relatively stable and were not characterized by much speculative activity. It was only after World War I that forex markets became very volatile and speculative activity increased tremendously. Back in those days, most institutions as well as the general public overlooked speculation in the forex market.
The Gold Standard
From 1876 to 1931, the gold exchange standard was used to back each country's currency and avoid arbitrary devaluation or inflation by leaders and institutions. However, the gold standard had its own weaknesses. When an economy's gold reserves ran out, the country's money supply would also diminish, causing interest rates to rise and slowing the economic activity. Recession would eventually follow and cause the prices of goods to extent that a recession would occur.
Eventually the recession would cause prices of goods to drop. Attracted by such low prices, other countries injected gold back in the economy. Money supply thus rose again, causing the interest rates to drop, and boosting the economy. These up-and-down movements lasted until the outbreak of World War I when the flow of gold stopped due to the disruption of the free flow of trade.
The Great Depression in 1929 and the removal of the gold standard in 1931 deeply affected the forex market activity. The forex market was bound to undergo revolutionary modifications and they occurred between 1931 and 1973. Global economies were greatly affected by these changes. These were years marked by very scarce speculation activity in the forex markets. Before World War II, Great Britain's currency, the Great Britain Pound (GBP,) was the major currency to which most currencies were compared. The Nazi campaign which resorted to extensive counterfeiting efforts against Britain's currency, put an end to its dominion.
The Bretton Woods Agreement
In 1944, towards the end of World War II, the United States, Great Britain and France met at the United Nations Monetary and Financial Conference in Bretton Woods, N.H., to establish a new global economic order. The fruit of their meeting entered history under the name of "The Bretton Woods Agreement" - a turning point in the forex market history. The agreement was designed to create a stable environment, so as to allow global economies to rebuild and reestablish themselves properly.
Under this agreement, national currencies were set against the dollar and countries agreed to see that the value of their currency remained within a narrow margin against the dollar. If a currency's exchange rate came to close to the set limit on either side of this standard, the country's central bank took it upon itself to intervene and bring the exchange rate back into the accepted range. The dollar was fixed at a rate of $35 per ounce of gold.
Following the war, construction efforts led to massive capital flows which in turn destabilized exchanged rates fixed under the Bretton Wood Agreement. In 1971, the Agreement was discarded. The agreement was nevertheless vital for that period and succeeded in bringing economic stability in Europe and Japan.
The Beginning of the Free-Floating System
In December 1971, the Smithsonian Agreement replaced the already expired Bretton Woods Accords. With this agreement, currencies enjoyed a greater fluctuation range. The following year, the European community made its first attempt to reduce its dependency on the dollar.
West Germany, France, Italy, the Netherlands, Belgium and Luxemburg established the European Joint Float. This agreement also allowed a greater range of fluctuation in the currency values. However, both agreements stumbled on the same mistakes that brought about the failure of the Bretton Woods Agreement and collapsed in 1973.
The collapse of both agreements marked the official shift to the free-floating system. This shift occurred almost naturally, for lack of alternative agreements. Governments were finally free to set their own rates for their currencies, semi-peg or allow them to float freely. In 1978, the free-floating system was made official.
In a further effort to gain independence from the dollar, Europe created the European Monetary System in 1978. However, by 1993, it followed the fate of its predecessors and was abandoned. Throughout the Eighties, with the boom of computers and new technologies, foreign exchange transactions grew exponentially to reach more than $1.5 trillion a day by 2000.
The Eurodollar Market
The evolution of the Eurodollar market also marked a turning point in the forex market history. The Eurodollar market was created in the 1950s when Russia deposited its oil revenue in USD outside the US to avoid a possible freeze by US regulators. Laws were implemented by the US government to oversee dollar lending offshore. With its fewer regulations, Euromarkets became more and more attractive to US companies. Today, London is the main market outside of the US and is the main player in the Euromarket.
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