The foreign exchange market (fx or forex) as we know it today originated in
1973. However, money has been around in one form or another since the time of
Pharaohs. The Babylonians are credited with the first use of paper bills and
receipts, but Middle Eastern moneychangers were the first currency traders who
exchanged coins from one culture to another. During the middle ages, the need
for another form of currency besides coins emerged as the method of choice.
These paper bills represented transferable third-party payments of funds,
making foreign currency exchange trading much easier for merchants and traders
and causing these regional economies to flourish.
From the infantile stages of forex during the Middle Ages to WWI, the forex
markets were relatively stable and without much speculative activity. After
WWI, the forex markets became very volatile and speculative activity increased
tenfold. Speculation in the forex market was not looked on as favorable by most
institutions and the public in general. The Great Depression and the removal of
the gold standard in 1931 created a serious lull in forex market activity. From
1931 until 1973, the forex market went through a series of changes. These
changes greatly affected the global economies at the time and speculation in
the forex markets during these times was little, if any.
The Bretton Woods Accord
The first major transformation, the Bretton Woods Accord, occurred toward 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
design a new global economic order. The location was chosen because, at the
time, the U.S. was the only country unscathed by war. Most of the major
European countries were in shambles. Up until WWII, Great Britain's currency,
the Great British Pound, was the major currency by which most currencies were
compared. This changed when the Nazi campaign against Britain included a major
counterfeiting effort against its currency. In fact, WWII vaulted the U.S.
dollar from a failed currency after the stock market crash of 1929 to benchmark
currency by which most other international currencies were compared. The
Bretton Woods Accord was established to create a stable environment by which
global economies could restore themselves. The Bretton Woods Accord established
the pegging of currencies and the International Monetary Fund (IMF) in hope of
stabilizing the global economic situation.
Now, major currencies were pegged to the U.S. dollar. These currencies were
allowed to fluctuate by one percent on 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 to bring the exchange rate
back into the accepted range. At the same time, the US dollar was pegged to
gold at a price of $35 per ounce further bringing stability to other currencies
and world forex situation.
The Bretton Woods Accord lasted until 1971. Ultimately, it failed, but did
accomplish what its charter set out to do, which was to re-establish economic
stability in Europe and Japan.
The Beginning of the free-floating system
After the Bretton Woods Accord came the Smithsonian Agreement in December of
1971. This agreement was similar to the Bretton Woods Accord, but allowed for a
greater fluctuation band for the currencies. In 1972, the European community
tried to move away from its dependency on the dollar. The European Joint Float
was established by West Germany, France, Italy, the Netherlands, Belgium and
Luxemburg. The agreement was similar to the Bretton Woods Accord, but allowed a
greater range of fluctuation in the currency values.
Both agreements made mistakes similar to the Bretton Woods Accord and in 1973
collapsed. The collapse of the Smithsonian agreement and the European Joint
Float in 1973 signified the official switch to the free-floating system. This
occurred by default as there were no new agreements to take their place.
Governments were now free to peg their currencies, semi-peg or allow them to
freely float. In 1978, the free-floating system was officially mandated.
In a final effort to gain independence from the dollar, Europe created the
European Monetary System in July of 1978. Like all of the previous agreements,
it failed in 1993.
The major currencies today move independently from other currencies. The
currencies are traded by anyone who wishes. This has caused a recent influx of
speculation by banks, hedge funds, brokerage houses and individuals. Central
banks intervene on occasion to move or attempt to move currencies to their
desired levels. The underlying factor that drives today's forex markets,
however, is supply and demand. The free-floating system is ideal for today's
forex markets. It will be interesting to see if in the future our planet
endures another war similar to those of the early 20th century. If so, how will
the forex markets be affected? Will the dollar be the safe haven it has been
for so many years? Only time will te
TIMELINE OF FOREIGN EXCHANGE
1944 Bretton Woods Accord is established to help stabilize the global economy
after World War II.
1971 Smithsonian Agreement established to allow for greater fluctuation band
for currencies.
1972 European Joint Float established as the European community tried to move
away from its dependency on the U.S. dollar.
1973 Smithsonian Agreement and European Joint Float failed and signified the
official switch to a free-floating system.
1978 The European Monetary System was introduced so other countries could try
to gain independence from the U.S. dollar.
1978 Free-floating system officially mandated by the IMF.
1993 European Monetary System fails making way for a world-wide free-floating
system.