History of Forex

history of forex

We humans have been known to evolve with time and experiences. People used to trade goods and services in a pretty good fashion even before the currency system’s advent. This concept of exchanging goods or services for other goods or services of equal value is called a Barter System. 

The barter system was the standard mode of transaction, which was followed by everyone during ancient times. The value of goods is measured according to the quality of the goods which are being exchanged. However, this system had its disadvantages because once the quality of goods decreases, so does its value.

Also, there was an absence of any measure to calculate the accurate value of goods to be exchanged. This resulted in the discontinuation of the barter system in favor of another system. Eventually, the concept of money was introduced, which was still in trend today.

Primarily, money works as a unit of exchange. It was favored because it used to have a fixed value. Coins were introduced as a form of money. 

Trading partners accepted this form of exchange system with open hearts. At first, they adopted a common valuable item as currency for exchanging goods such as silver or gold. Then they realized the benefits of paper currency. Its many virtues such as common value, easy to carry, good exchange power, etc. convinced them to value it.

Almost all countries in the world followed their lead and accepted the paper currency system. Later on, a new problem arose, i.e., every country issued its currencies in markets. This created an issue while trading in the international market, as every country’s currency has different purchasing power and value.

The concept of forex revolves around the concept of trading of currency. The Forex market can be called the world’s biggest, most accessible, and highly liquid market. The Forex culture was not always like this; what we see today. The Forex market, which we see today, is, in fact, the result of various events and developments which made it a global success today.

 

 

What is Forex?

Forex is a global market that primarily deals with currency trading. It is an over the counter (OTC) or decentralized market. Forex is known by various names such as FX, foreign exchange market, or currency market. Forex markets determine the rate of foreign exchange for all currencies.

The process of changing one particular currency to another currency is called Foreign exchange. Foreign exchange can be done for a number of reasons such as trading, commerce, tourism, etc. Currencies are traded against each other in pairs. 

If we talk about trading volumes, then forex is the world’s largest trading market. The world’s big international banks participate in this market. It is a well-known fact that the currencies are traded in packs. It means that one can exchange currency with another currency. Thus, two currencies are needed.

Timeline of events 

    • 6th Century BC – First Gold Coin was made.
    • 15th Century – Families were posted by the merchants in other territories to act as currency exchange points.
    • 16th Century – The concept of financial markets was introduced. 
    • 1819– The Gold Standard was introduced. It was formally adopted by England.
    • 1834 – America formally accepted the Gold Standard.
    • Mid-19th Century – The concept of foreign exchange has become very popular. A company named Alex. Brown & Sons became the leading currency trading company in the market. 
    • 1870 – All other major countries, i.e., Germany, France, and Japan, accept the Gold Standard.  
    • 1880 – Gold Standard was introduced worldwide. This year is also known as the advent of the modern Foreign Exchange System.
    • 1914 to 1939 – The Bretton Woods System was introduced. During the First World War and the Second World war, the Gold standard dissolved under the situation. This new system was introduced to combat this situation.
  • 1971 – The Bretton Woods System was ended. 
  • 1972 – The European Joint Float was made by the European Countries.
  • 1973 – Official switch is done to Free Floating System after the fail of both the European Joint Float and Smithsonian Agreement. Control of State on Forex in almost all developed nations ended.
  • 1979 – The European Economic Committee was introduced.
  • 1985 – The Plaza Accord was made. The leaders from G-5 met together at the Plaza Accord. They made an agreement to lower the value of the US Dollar.
  • 1992 – the Maastricht Treaty was signed. This treaty further played a part in the formation of the Euro and the Eurozone.
  • 1996 – Internet Trading on Forex was started. Now you can access forex at any time.  
  • Today – Forex trades around $5 trillion every day. 

Forex plays a very important role in the growth of international investments and trades by allowing the conversion of currencies. The development of forex as an international market did not happen in one day. It took years to develop the complete system. 

History of Forex

The concept of forex as we define it now is fairly new. It is, however, true that people are converting currencies for financial benefits and trade since the dawn of time. But the present forex principles and market features are truly modern.

To understand the history of forex, one must go back to ancient times and then move forward to recent times. 

Ancient Times

The concept of trading goods with currency was introduced by our ancestors. During Biblical times, there were some people called as money changers. These people used to take a commission on behalf of exchanging money. 

The first gold coins were produced around 6 BC. These coins were used as money because they have ideal characteristics of a currency, such as portability, uniformity, and acceptability.

The exchange of currency was a very important aspect of trade and commerce during ancient times. Countries have started minting gold and silver coins for conducting trades. They used to differentiate between their coins based on which coins are made of more gold or silver. 

Gold coins were accepted as an exchange medium; however, many of them were heavy, making it impractical to carry them. This is one of the primary reasons why most currencies in today’s world have their currency’s value fixed according to gold or silver standards. 

Medieval 

In the 15th century, some families were asked to represent the textile merchants in foreign countries for exchanging currency on their behalf. A number of other systems were also introduced so that a standard currency exchange system can come into the market.

Financial Markets 

Financial markets started sometime during the sixteenth century. These markets were very simple in their working activities. They acted as places where different countries can settle their trades. These markets also allowed traders to earn some profits when different country’s currencies were exchanged.

Within a few years, the concept such as banknotes, securities, etc. came to be known within the trading sectors; however, there was no dominant currency in the market. This status quo diminished when the first cable link between the United States and Europe got established in the year 1866. As a result, several bankers and businessmen of Europe started settling in London. This year marked the changing year of financial markets around the globe. 

The pound was a strong currency, but its value was nothing as compared with gold. This brought the concept of the Gold Standard, which remained as a standard and stable exchange rate denominator for years.

Amsterdam had also developed and maintained a Forex market during the 17th or 18th century.

Early modern

By now, the foreign exchange has become a very popular market. A trading company called Alex. Brown & Sons was the leading currency trading company in the market during the mid-19th century. Later on, a number of other companies were also allowed to engage themselves in this business.

Rise of Gold Standard 

Gold Standard of exchange began worldwide in the year 1880. This is known as the advent of modern FX or foreign exchange in the world. Under this standard, the value of a currency was decided based on how much gold can come in exchange for those currencies. 

This standard required that the countries following the gold standard must maintain their regular money supply up to a fixed gold quantity. Thus, imposing a condition on the governments that they can issue more money only if their country had more gold. 

This condition was imposed to prevent nations from printing money for paying foreign traders. This was the basis of foreign trade. 

This policy also required a free flow of gold between countries so that countries can import and export as much as gold they want. However, they had to always maintain a certain amount of gold to keep up their currency.

Modern to post-modern

By this time, countries that have foreign exchange have seen a tremendous increase in their overall growth. Apart from their growth, their gold reserves also increased at a high rate. 

The Pound Sterling became the mode of conducting about half of the world’s foreign exchange. Growth was also seen in many other sectors around the foreign exchange trade departments. From the number of foreign banks to foreign exchange brokers, all increased within the premises of London. 

After world war 2

After the end of the world war, all nations were in economic crises. This time saw a number of changes in the entire foreign currency system. A number of new reforms were introduced, and several old reforms and standards were revoked.

Fall of Gold Standard 

After the popularity of gold standards for a few years, it began to fall. The main issue with this standard was that if a country did not have enough resources, then it would lose gold. Less gold will result in less money, affecting the country’s overall economy. It will affect not only the country’s economy but also its people’s employment and incomes.

The Gold standard came to an end with the first world war. Countries like Germany started printing currency without any backing of gold, resulting in reducing the currency’s value. This war led to the downfall of the gold standard. 

Many attempts were made to bring back the gold standard, but all of them failed. The reason behind this is that it had a number of faults, such as; 

  • When a country’s economy boosts, it may increase its import and decrease its gold reserves. This would result in the downfall of the economy.
  • Countries cannot have an independent economic policy.
  • One of the main reasons for ending the Gold Standard is because, after the First World War, many governments printed their currency without any gold backup.

Bretton Woods Agreement

The Great Depression and the fall of the Gold Standard caused a serious gap in the foreign exchange market. From the years 1931 to 1973, the whole foreign exchange market saw a number of changes, which led to its overall development. These changes also brought many changes in global economies.

In 1944, all allied nation’s leaders decided to meet at Bretton Woods. The intention behind this meeting was to set up a better and developed system for fixing foreign exchange rates. 

After the Bretton Woods agreement was signed, the dollar started to show prominence in the world market. This was because the only dollar has the currency value to be able to convert into gold. This new prominence introduced the concept of dollar dominance in the market.

Institutions like the IMF, GATT, and the World Bank were created. Thus, the Bretton Woods agreement made a system for foreign exchange to support wounded and falling economies. It also partially allowed the Gold Standard and made the US dollar the standard exchange currency.

End of Bretton Woods

The Bretton Woods system displayed the signs of downfall in the 1960s. The markets became more and more complicated. This new market regime required a modern and more flexible monetary system. 

The US dollar does not have enough money to back the gold for currency circulation. Finally, in the year 1971, this system was ended by the then President of the U.S. Richard M. Nixon. 

The European Joint Float 

After this year, the U.S dollar cannot be converted into gold. In the year 1972, the European nations tried to shift their dependency on U.S. dollars. Countries such as France, West Germany, Belgium, the Netherlands, and Luxemburg decided and made the European Joint Float.

Smithsonian Agreement

The Smithsonian agreement was signed in a meeting held in December of 1971 at the Smithsonian Institution. This agreement was signed by the Group of 10 countries. 

After the Gold Standard was removed by President Nixon in 1971, the country was in great distress. The President thought that the free market functions in the foreign exchange would result in more distress worldwide. Also, this will result in the devaluation of several currencies. 

Thus, he tried to persuade the leaders of the Group of 10 to sign an agreement called the Smithsonian agreement. This agreement said that all the Governments of 10 would try to keep their exchange rates fixed to the dollar. The dollar will not be fixed to gold. 

In reality, this agreement was like the Bretton Woods agreement but without the backing of gold. The Central governments were also given some liberties. They were able to fluctuate their rates by up to 2.5%.

This agreement was ambitious, nevertheless, ultimately a failure and did not last for more than two years. This also resulted in the complete closure of the forex.

Trade deficit 

The Bretton Woods System, The European Joint Float system, and the Smithsonian agreement all of them made a number of mistakes. These mistakes ultimately led to their failures. After these failures, all the countries officially switched to the free-floating systems. 

The agreements looked weak and improper on paper. However, when they faced the real issues of the trade market, they completely crumbled. All these failures led to the trade deficit, which kept on increasing with time. In 1972, the gold’s value reached as high as $210 an ounce. 

All these failures resulted in abandoning these agreements by signing the countries and, ultimately, the acceptance of the Free Floating system.

Free Floating System

By the year 1973, the nation’s major currency started to get regulated by supply and demand theory. Gold reserves did not play any part in their valuation. 

These prices started to change on a daily basis, thus, giving rise to a number of new financial instruments. Concepts like trade liberalization and market deregulations were also introduced by the countries.

Jamaican System 

The Jamaican System started in Kingston, Jamaica, in the year 1976. Countries were given a choice to choose any form of exchange rate they want.  The Exchange rate is defined according to the market’s supply and demand. Similarly, currency relations are based on floating exchange rates. 

Factors according to which the currency rates work

  1. Supply and demand rate of national currencies in the international markets.
  2. Domestic currency’s purchasing power at the international markets

Generally, a country’s demand for foreign currency depends upon its tourists, imports, external payments. 

Markets close

Forex markets were forced to close down after the ineffectiveness and failure of both the European Joint Float and the Bretton Woods Accord. 

One of the major reasons for the growth and development of Forex trading is the growth of the Eurodollar market. These are primary markets under which the U.S. dollars are deposited but outside the banks of the United States.

Under these markets, assets are deposited outside the currency’s origin country. These markets first emerged when in 1950, the oil revenue of Russia, all in U.S. dollars, was deposited outside the United States. This was done from fear that U.S. regulators will freeze all the Russian deposits. It was the largest purchase of U.S. dollars till that time. 

This incident threw light over the fact that all the measures developed for regulating foreign exchange markets were not enough. As a result, all the forex markets and monetary systems of European countries were closed for two weeks. 

After 1973

Control of State over foreign exchange ended in the year 1973 in almost all developed states. This happened when free-floating and free-market conditions began to prevail in modern markets. 

In the year 1979, the European Economic Committee introduced a new and fixed system of exchange rates. This system was called the European Monetary System. Europe took these steps as an effort to make its currency stable.

After this, Europe signed the Maastricht Treaty in 1991 with hopes of stabilizing their currency. By the 1980s, London became the main center of the Eurodollar market. This happened because the British banks started lending dollars to potential debtors as an alternative to pounds. This step was taken by the British banks for maintaining their leadership position in the global market.  

Plaza Accord

During the early 1980s, the dollar was greatly favored against all major currencies of the world. This resulted in stagflation, the interest rate increased. All of this resulted in a strong rate of the US dollar, but at the expense of the US, the industries in the global market. 

The high rate of the US dollar resulted in the downfall of economies of third-world countries. These countries suffered from loan debts. These nations decided to close American factories because they cannot compete with these factories. 

In 1985, the US, France, Great Britain, Japan, and West Germany, the G-5 countries, decided that they would conduct a meeting. They send each of their representatives in a secret meeting at New York City’s Plaza Hotel. This was supposed to be a secret meeting; however, the news was leaked. This forced the G-5 countries to make a positive and encouraging statement for other currencies except for the dollar. 

The traders soon realized that investing in this new world is very effective and profitable. The government tried to interfere with these fluctuations, but they were still very strong, and thus, the traders were able to make a good profit. 

Growth to popularity 

By the year 1982, the first currency pairs were traded by retail customers. After this, some more currency pairs were released and became available in the general market. 

By the year 1987, the most number of trades were done by the UK, while the U.S. was close behind. Iran also decided to amend its agreements with different countries to use the foreign exchange instead of oil. 

Forex was previously considered as an activity that was taken by businessmen who took its education. It was also considered as something which was the job of a person who had learned trading at business schools or college.

Technology and the internet have done a lot of favors to new and emerging markets such as forex.  However, after the advent of the internet, things have changed.

Internet Trading

The currency market saw a great increase in the year 1990. The currency market became more and more complicated and fast. The way people now deal with the internet and its resources these days have created a great impact on finance as well as foreign exchange sectors.

This technology changed everything for forex. Currencies that were not available because of a country’s internal politics are now openly available. Third world countries such as Southeast Asian countries have taken advantage of these situations.

These countries are now one of the most emerging markets in this sector. Now, forex is open to all types of people and investors.

Within the past few decades, forex has become a very popular mode of investment. Forex is now available at all times. Forex is said to never sleep. An investor can trade in it 24/7, without any limit.

Forex and the present situation

Forex has now become one of the most active and largest liquid markets around the globe. Now, people have a choice to choose from a number of currencies. These currencies include all types of pairs, from major pairs to the most exotic pairs; you have the liberty to choose anyone.

A number of educational resources are also present in the market, which significantly increases the chances of the trader’s success. There are also many tools, such as analytical tools, social media, which can also be helpful. Brokers and third party information is also easily available, which may help you in your trading.

These and many more technological advancements such as mobile phones, the internet let you invest in whichever market you want. You don’t even need to have a lot of money for trading in the market. 

 

In Summary

Forex has had a long, detailed history. The forex market we see today has been made after a number of successes and failures on the part of world governments. All the forex markets of the past were majorly dominated by big key players, such as governments and banks. But with the advent of new forex regulations and globalization, anyone can access forex markets.

The future of forex is, though not clear, because of its ever-changing nature. However, it has come a long way, and one can only hope that it will last for a long time in the currency exchange market.

Now that you have gained all the knowledge about the history of forex, if you are looking for some practical trading experience, create a demo account. Demo accounts at XTB or IC Markets will help get the ins and outs of trading without risking your money.