Forex History

The Forex market as it is known now, accessible to independent traders the world over, was truly born of advances in computer technology. After the abandonment of the gold standard in the 1970s, the value of the world’s currencies became free floating, subject to a variety of forces including supply and demand, political policy, and macro-economic influences. Once the sole domain of banks and governments, the Forex became accessible to speculative traders of all kinds as trading technologies for individuals were developed. Lacking both a commission model and a physical exchange that would have drawn the participation of brokerages, the Forex was not adopted by brokers who execute trade orders on behalf of clients in stocks or commodities. Rather, the completely electronic Forex was extremely well-suited to electronic trading. A British company has laid claim to being the first to have offered an online Forex trading platform and executing the first online Forex trade in 1996.

While other markets may be seen as requiring unique research or arcane knowledge, everyone is familiar with money and the variability of its buying power. Information about the economy is readily available in every form of news media. With a broad selection of electronic trading platforms geared toward the independent trader and lot sizes that reduce the barrier to entry, it’s no wonder the retail Forex market has drawn millions of speculative traders as it’s grown since the mid-90s. The appeal of the world’s largest and most dynamic market is undeniable! Remember, there is a substantial risk of a loss in all trading. Trading foreign exchange rates may not be suitable for all investors.

Gold Standard

Throughout millennia, gold has been held in high esteem as possessing its own inherent value and used as currency and as a store of wealth. It was only logical then, that as more portable forms of currency were developed, they were created to represent a valuation determined by gold. Establishing a monetary system in which the value of currency is based on and exchangeable for a fixed weight of gold is using a gold standard. A gold standard system requires that a store of gold be maintained to back the monetary notes in circulation. As industrialization developed, gold reserves were seen as an indication of a nation’s stability and wealth.

The gold standard proved to be difficult to maintain, particularly through times of war. It has been considered by some to limit the ability of central banks to manage monetary policy, having potentially adverse impact on the money supply and interest rates.

Bretton Woods System

Against a backdrop of a chaotic world at war, Bretton Woods was a meeting of several hundred delegates representing some 44 Allied nations, seeking to rebuild the world’s devastated economic system. The United Nations Monetary and Financial Conference met at the Mount Washington Hotel in Bretton Woods, New Hampshire over three weeks in July 1944. Delegates drafted an agreement for the formation of international organizations that would establish a system of institutions, procedures, and rules aimed at regulation of the international monetary system. The International Bank for Reconstruction and Development and the International Monetary Fund would become operational in 1945 following ratification by a plurality of countries.

The Post-WWII years found the United States with an immense balance of trade surplus while a dollar shortage plagued Europe’s struggle to economic recovery. The US established the Marshall Plan to aid post-war recovery efforts through an outflow of dollars aimed in part at rebuilding productivity and expanding export capacity for Japan and Europe. The program encouraged trade and the exchange of raw materials and export goods between the US, Europe, Japan, and developing nations.

Chief among the agreements established by Bretton Woods was the requirement that countries peg their own domestic currency to the US Dollar, which at that time utilized a gold standard. By 1949, the Japanese Yen, Deutsche Mark, British Pound Sterling, French Franc, and Swiss Franc were among the world’s major currencies complying with the Bretton Woods agreement. Gold convertibility would remain a cornerstone of the Bretton Woods system but only for the world’s reserve currency, the US Dollar.

By the late 1960s, the tenets of Bretton Woods had become strained and it was believed that the world’s supply of gold and the utilization of the US Dollar as the world’s reserve currency were insufficient to maintain on-going international liquidity and to sustain continued global economic growth.

Initiating what would be called the “Nixon Shock,” Richard Nixon terminated the US Dollar’s convertibility to gold in 1971, effectively bringing the Bretton Woods system to an end.

The start of Currency Exchange Rates

Maintaining a fixed gold standard value for the US dollar ultimately could not be maintained as the global economy attempted to evolve. After the Nixon Shock and the complete abandonment of the Bretton Woods agreement, the world’s currencies would be free floating with exchange rates that could be calculated against each other. Floating currency rates will be a reflection of the forces that drive a country’s economy.

Dollarization

Dollarization is simply when a country adopts the US Dollar as its own currency. Dollarization is an alternative to pegging a currency or attempting a floating rate currency in a national economy that may prove too volatile. The strategy is largely used by emerging countries attempting to stabilize and develop an economy and nurture a climate that will attract investment.

Introduction of the US Dollar as a country’s legal tender may effectively reduce risk and virtually eliminate the possibility of attempts to manipulate economic factors that could have adversely impacted a country’s own currency under a floating rate system.

Pegged Rates

A country may attempt to stabilize its currency by tying or “pegging” its exchange rate to the currency of another country. The pegged currency will rise and fall with the fluctuations of the reference currency. The US Dollar is usually the currency of choice for pegging and is considered an attempt by a nation to facilitate trade and investment with the United States. A drawback of the strategy is in how it limits a nation’s ability to enact its own monetary policy.

China pegged its currency to the US Dollar for a decade, finally allowing the Yuan to float in 2005. In this case, the peg actually incited friction with the United States as it was considered to have kept the Yuan artificially low, thereby making Chinese exports unfairly cheap. Termination of the pegged currency was welcomed by the US.

Managed Floating Rates

When a country’s central bank intervenes in an attempt to stabilize a floating currency rate, the float is considered “managed.” The intervention is often implemented by buying and selling large amounts of currency in an attempt to maintain the floating rate within a range.