The History of the Forex Market
Introduction
The foreign exchange, FX or forex market, as we know it has been
evolving for hundreds of years. It is believed that the concept
of banking first arose in ancient Mesopotamian times. Royal palaces
and temples were used to store harvested commodities which in turn
created the need for receipts. These receipts were used for transfers
to those who made the deposits and to third parties. The very same
banking and receipt business was also used in ancient Egypt. Receipts
were often used to settle debts with priests, tax collectors and
exchanged with traders.
It wasn’t until the early forms of coinage
came about that we saw the first real currency traders. As empires
were divided, expanded, conquered and founded the currencies of
different cultures had to be exchanged for one another.
During the Middle Ages paper bills replaced coins as the currency
of choice. This made foreign exchange much easier. At this point
things remained relatively stable in the World of foreign exchange
until the First World War.
At the end of WWI there was a brief period of massive currency
speculation. The official view on currency speculation at this
point was decidedly negative but no regulations were ever drawn
up. This speculation came to a crashing halt with the arrival of
the ‘Great Depression’. This World recession effectively
killed any growth in FX speculation as disposable income was at
a premium. Sentiment returned to favouring stable exchange rates
until the Second World War brought about some factors that would
force governments to regulate their currency rates.
The Bretton Woods Accord
Until the start of WWII, the British Pound
Sterling (GBP as we know it today) was the World’s most prominent currency. It
was against the GBP, and not the dollar, that most other currencies
were compared. However, the arrival of war saw a massive Nazi counterfeiting
campaign aimed at devaluating the Sterling. The campaign worked
and the World’s confidence in the GBP was shaken. At this
time neither the United States nor its Dollar Currency had endured
this devaluing campaign or the strain of War on domestic infrastructure.
The US Dollar had been out of favour due to the massive stock market
crash in 1929 but the economy had recovered and it was seeing a
boom cycle once again.
At the end of WWII the World’s economy, with the exception
of the US, was in disarray. Representatives from the US, Britain
and France met at Bretton Woods, New Hampshire with the objective
of creating an infrastructure that would allow the rebuilding of
the World’s economy. The result was the Bretton Woods Accord.
The Accord decided that the US Dollar would become the World’s
benchmark and all other countries would measure the value of their
currencies against it. Part of this agreement was the Gold Standard
which fixed the price of Gold at $35 an ounce. All other currencies
were pegged to the dollar at a certain rate. This rate was not
allowed to fluctuate more than 1% in either direction (higher or
lower). If a fluctuation greater than 1% did occur then the relevant
central bank had to enter the market and restore the exchange rate
to within the accepted band.
There are mixed opinions as to whether the Bretton Woods Accord
was successful in restoring economic stability to Europe and Japan.
Despite this, the agreement eventually failed in 1971. It was superseded
by the Smithsonian Agreement.
Timeline |
1944
|
|
1971 |
The
Smithsonian Agreement
|
1973 |
The
Smithsonian Agreement fails - start of The Free Float
System .
|
1978 |
The European Monetary System |
1993 |
The European Monetary System Fails |
1999 |
Launch of the Eurozone Single Currency
- The Euro |
The Smithsonian Agreement
The Smithsonian Agreement tried to succeed where Bretton
Woods had failed. Rather than give a 1% margin, greater room for
manoeuvre was introduced.
Not long into this agreement, Europe made its first attempt at
breaking free from the Dollar dominated system. In 1972 Europe
formed the European Joint Float. Member nations included West Germany,
France, Italy, the Netherlands, Belgium and Luxembourg. This agreement
was very similar to Bretton Woods but with a larger band for rate
fluctuation.
Just as their predecessors had failed, these agreements were flawed
and subsequently fell apart. However, this time there was no new
agreement to take its place. For the first time since WWII there
was a ‘free float’ system in place. This was not the
result of some Genius planning; it simply existed because there
was nothing else to replace it. The value of each currency is now
governed completely by the laws of supply and demand. Large banks,
private companies and individual speculators are all active participants
in the Forex market. The Internet boom and the increasing ease
of access to foreign exchange has further increased participation,
especially that of individual speculators.
However this lack of official restraint hasn’t stopped central
banks from trying to manipulate the value of their currencies in
the free float system.
The European Monetary System
The European Economic Community (EEC), as it
was known in its early days, established the European Monetary
System in 1978. Its purpose was to regulate the value of EEC members’ currencies
against each other. A rate fluctuation band of 2% was introduced.
As previously seen in the Bretton Woods and Smithsonian agreements,
central banks were required to maintain this band. The problem
with this system was that it failed to recognise the number of
private speculators that were now active participants and their
cumulative financial might. This mistake was very costly for the
Bank of England (BOE). In 1993 speculators made an attack on the
GBP forcing the bank to intervene. The financial attack was so
strong that the BOE deemed currency regulation too expensive and
withdrew from the European Monetary system. This led to the collapse
of the system leaving the free float that has remained unchallenged
to the present day.
The Eurozone Single Currency
The official currency of the European Union (EU), the Euro, was
launched in 1999 with coins and banknotes issued in 2002. Current
member nations are: Austria, Belgium, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and
Spain. It is possible for any member of the EU to join as long
as they adhere to the strict monetary requirements. The Euro is
managed by the European Central Bank (ECB) which has the authority
to set monetary policy over all of its member states. The formation
of the Euro is seen as the beginning of evolution towards a single
European state as the Eurozone attempts to compete directly with
the US. The Euro is now one of the most heavily traded currencies
in the World.
Back
to Forex Market Dynamics and History Articles - Market
Liquidity: The Currency Market vs The Stock Market
