Here’s a brief historical overview of currencies and foreign exchange trading.
Many early instances of money were objects which were useful for their intrinsic value as well as their monetary properties. This has been called commodity money; historical examples include iron nails (in Scotland) pigs, rare seashells, whale’s teeth, and (often) cattle. In medieval Iraq, bread was used an early form of currency.
The use of shells or ivory was nearly universal before humans discovered how to work with precious metals; in China, Africa, and many other areas, use of cowrie shells was common. In China the use of cowrie shells was superseded by metal representations of the shells, as well as representations of metal tools. These imitations may have been the precursors of coinage.
When coinage began in 700 B.C by the Greeks, it was adopted by almost every other nation in a relatively short period of time. The development of each nation varied, the perceived value of their currencies also. The more civilised a nation and what it could offer its people, the more valuable their currency.
The Babylonians are credited with the first use of paper bills and receipts. These paper bills represented transferable third-party payments of funds, making foreign currency exchange trading much easier for merchants and traders and allowed flexibility and growth in foreign exchange dealings. In different economies, everything from teeth to feathers to pretty stones has served this purpose, but soon metals, in particular gold and silver, established themselves as an accepted means of payment as well as a reliable storage of value.
There have been a number of exchange rate regimes since modern civilisation began. An exchange rate regime regulates the question of whether exchange rates are set flexibly on the market, or are fixed by the intervention of central banks.
The gold standard was established by the industrialised nations towards the end of the 19th century. It was the gold standard which first produced the notion of foreign exchange dealing as we know it today.
Gold Standard Regime Dates:
1880 – 1914
1918 – 1939
The Gold Standard provided a system of fixed exchange rates and was considered an instrument of confidence. International payments were made in gold an gold could be imported and exported globally without restriction. Countries participating in the Gold Standard were obligated to cover a large percentage of their paper money stock in global circulation with gold. Gold coverage and its free movement globally guaranteed the stability of exchange rates.
The standard worked well for all nations involved until the Great War of 1914. Heavy debt and political alliances made the standard unworkable. Around that time the British pound sterling and U.S. dollar became the global reserve currencies, and small countries began holding these currencies instead of gold.
Post World War I, the market became highly speculative and changes for the first time began emerging and paved the way to what the market is today. In 1930, the Bank for International Settlements was established in Basel, Switzerland, to oversee the financial efforts of the newly independent countries and to provide the monetary relief to countries experiencing financial difficulties.
London became the leading center for foreign exchange by the mid-1930s and the British pound (GBP) served as a the currency to trade and to keep as a reserve currency.
Higher interest rates during the depression caused England to suspend the gold standard in 1931, leaving the US and France the only countries with large gold reserves.
In 1933, the U.S. government banned the export of gold, halted the convertibility of dollar bills into gold and ordered its citizens to hand in all the gold they possessed.
At the end of World War II, the U.S. had 75% of the world’s monetary gold, and their currency was backed by gold. The British economy was all but destroyed due to their dramatic rise in debt to fund the war as well as the Nazi campaign’s efforts to destroy the British economy by a major counterfeiting program which introduced large sums of British notes throughout the war. Most European countries were also in disarray which gave rise for the U.S. dollar to be catapulted from near worthlessness into global dominance.
In 1934 the US government revalued gold from $20.67 to $35 per ounce so that more paper money could be printed. This helped improve the economy. Other countries began to convert their gold holdings into U.S. dollars, and soon and the U.S. cornered the gold market.
The U.S. dollar became the new backbone of the world’s economic stability and a number of measures were taken to maintain its continued stability. With all currencies ‘pegged’ against the U.S. dollar, currencies were allowed to fluctuate by one percent on either side of the set standard on the market. 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.
In 1944, western nations met to put together the Bretton Woods Agreement, which was the framework for global currency. The agreement also spawned the creation of the International Monetary Fund (IMF) and the World Bank.
The Bretton Woods monetary system pegged the U.S. dollar agains that of gold and gold prices globally were fixed at $35 an ounce. This system maintained economic stability while nations that were affected by war could rebuild their infrastructure and re-negotiate trading agreements with other nations. The new gold standard set par values for currencies in terms of gold and obligates member countries to convert foreign official holdings of their currencies into gold at these par values.
During the 1960s inflation and a high demand for imports started taking its toll on U.S. gold reserves. In 1968 the U.S. and other European nations which made up a “gold pool” quit selling gold on the London market. The U.S. recorded its first deficit in its balance of trade in more than 70 years due to excessive defence expenditure as a result of the Cold War and the escalating Vietnam War expenditure.
To maintain dollar parity, the European central banks had to introduce their currencies onto the market, which drove up inflationary expectations. The fear of inflation caused a run on gold, the exchange of which was still guaranteed, and the market price exceeded the fixed rate of USD 35 per troy ounce. To head off this crisis on the gold market, the central banks decided to co-operate in a gold pool. The objective of the pool was to guarantee the gold price at the official level of USD 35 per troy ounce by means of intervention.
With capital increasingly flowing out of the U.S. dollar, President Nixon announced the unilateral suspension of the dollar’s convertibility into gold in August 1971 which led to the demise of the Bretton Woods Agreement. Although the system failed, it did achieve its primary objective of restoring European and Asian economic stability. Post Bretton Woods, the Smithsonian Agreement was introduced which was formed to allow greater fluctuation of deviation for currencies. This was a short lived system and it ultimately failed along with the European Joint Float which was an attempt by certain European nations to move its dependency away from the U.S. dollar. International countries, led by Germany, redeemed large sums of their U.S. Dollars for physical gold from U.S. gold reserves.
With no system in place to regulate or peg their currencies against, countries were able to to freely float their currencies and in 1978, the free-floating currency system was officially mandated and the Forex market began to evolve in its own right.
The EEC (European Economic Community) introduced a new system of fixed exchange rates in 1979, the European Monetary System. This attempt to fix exchange rates met with near extinction in 1992-1993, when pent-up economic pressures forced devaluations of a number of weak European currencies. Nevertheless, the quest for currency stability has continued in Europe with the renewed attempt to not only fix currencies but actually replace many of them with the Euro in 2001.
The lack of sustainability in fixed foreign exchange rates gained new relevance with the events in South East Asia in the latter part of 1997, where currency was devalued against the U.S. dollar, leaving other fixed exchange rates, in particular in South America, looking very vulnerable.
Currencies move independently of one another and provide an ideal trading platform for today’s Forex markets. All currencies today are traded by anyone who wishes. Subsequently, this creates volatility from which large sums of money can be made or lost.