History of Forex

Barter
Currencies based on Gold
Paper money exchanged for gold (reserves)
“Run on the Bank”
Bretton Woods
Created IMF, World Bank, GATT
European Monetary System
Maastricht Treaty
SE Asia 1998 Crisis

It used to be that the value of goods and services were expressed in terms of other goods. This was called the barter system. Carrying around goods as a medium of exchange can be a little cumbersome, so some economies began to use specific goods, such as feathers, polished stones, special metals (gold & silver) as a medium of exchange. The first coins were made from gold and silver. During the Middle Ages, economies began to use paper money to exchange value as an I.O.U.

Prior to WWI, central banks supported their currencies through convertibility to gold. Paper money could be converted into gold by request to the bank. Because it was likely that all holders of paper money would request gold at the same time, banks only needed to keep a determined amount on hand to handle normal exchange requests (gold reserves).  Therefore, the amount of money outstanding was increasing relative to the amount of actual gold on hand. During times of crisis, when the confidence of the financial system was low, we had such events as a “run on the bank.”  That was when a large amount of currency holders requested conversion into gold at the same time, especially if it
was more gold than the bank had on hand. Political instability and inflation were the results of an increased supply of paper money (IOUs), relative to gold reserves. Foreign exchange was affected by such events due to its impact on the economy.

Subsequently, foreign exchange controls were introduced to control the forces of supply and demand’s. In July 1944, towards the end of WWII, the Allied countries (U.S., Great Britain, France) met at the  United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire. Their intent was to structure a world economic system that would stabilize the volatility in the foreign exchange markets that had occurred previously. The result was the Bretton Woods Accord which determined a system for pegging currencies and created the International Monetary Fund.  The Accord fixed the US Dollar at $35 per ounce of gold and fixed other currencies to the dollar. 

Subsequently, there were other changes that took place in regards to the Accords. During the 1960s the volatility between different country economies became more extreme, making it difficult for some to maintain the pegging system. Bretton Woods collapsed in August, 1971, when President Nixon suspended the gold convertibility standard.  The dollar had lost its attraction as the sole international currency due to the impact of growing trade deficits and government budget deficits. 

Since then the foreign exchange market has grown into the world’s largest market. In 1979, the European Economic Community introduced a new system of fixed exchange rate call the European Monetary System. This system almost disintegrated in the early 1990s when a number of European countries were forced to devalue their currencies.

In their continued attempt to stabilize foreign exchange, the European Community signed the Maastricht Treaty.  The treaty was designed to fix exchange rates that would eventually evolve into a single European currency, called the Euro. The Euro replaced many of the member currencies in 2002.

The quest continued in Europe for currency stability with the 1991 signing of The Maastricht treaty. This was to not only fix exchange rates but also actually replace many of them with the Euro in 2002. Today, Europe is currently in the Euros third and final stage, where exchange rates are fixed in the 12 participating Euro countries but still use their existing currencies for commercial transactions. The physical introduction of the Euro will be between January 1, 2002 and July 1, 2002. At that point the old countries currencies will be obsolete. In Asia, the lack of sustainability of fixed foreign exchange rates has gained new relevance with the events in South East Asia in the latter part of 1997,
where currency after currency was devalued against the US dollar, leaving other fixed exchange rates in particular in South America also looking very vulnerable. While commercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have discovered a new playground.  The size of the FOREX market now dwarfs any other investment market. It is estimated that more than USD 1,600 Billion are traded every day, that is the same amount as almost 40 times the daily USD volume on the American NASDAQ market.

Participants in Forex

Banks
Trade through the interbank market.

Sam Seiden - Author
Sam brings over 15 years experience of equities, forex, options and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated hundreds of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.

Points of interest:
• Chicago Mercantile Exchange Floor
• Author of Market Advisory Letters
• Fund Manager/CTA
• Speaker to Investment Groups, Universities, and Private Seminars
• Contributing Author for Stocks, Futures, and Options Magazine, Active Trader Magazine, and Futures Magazine
• Trading and Investment Conference Speaker