How the Foreign Exchange Market Came to Be
The foreign exchange, forex, or FX market is a juggernaut. According to the Bank of International Settlements (the global equivalent of nations’ central banks), around $5.1 trillion is being exchanged in the market. These trades represent tourism, international commerce, and even government trades. It is the largest market by volume around the world.
Despite the foreign exchange market’s enormity, most people still don’t know much about it apart from their interactions with it when they buy goods from other countries online or when they trade some of their local currencies during holidays abroad.
This article will explain the long history of the forex market: its beginnings, its highlights, and how it became the giant that it is today.
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It’s difficult to look into the history of the forex market without first revisiting the history of commerce and money.
In ancient times, bartering was the way people traded their goods for other goods. A farmer would trade sacks of wheat for another’s chickens or pigs. This system seems straightforward, but it’s also riddled with issues and inconsistencies. For one, there was no set value for the goods being traded which can lead to a lot of one-sided deals.
As commerce evolved, some societies began using objects to represent value. Seashells, rice, and others were used to trade in exchange for other goods. Contrary to popular belief trading with gold and other precious metals wasn’t as widespread back then because of the difficulties of acquiring these metals.
Eventually, the first coins were minted in Lydia (present-day Turkey) in the 7th century BC. Compared to other objects that came before it, the coins were easier to standardize. However, they also posed some issues that need to be addressed. For one, coins, in large quantities, were difficult and dangerous to carry. In many cases, the weight of the coins was used to determine their value. This posed another issue in that the weight of the coins changed over time.
In the 7th century, paper money was developed in China’s Tang dynasty. It solved many of the issues that coins posed. It was lighter and easier to carry in large quantities. When European explorers like Marco Polo visited the region and returned home, they introduced the system of paper money.
Paper money used to be a representation of how much gold people owned in the banks. This worked well for a time.
However, eventually, banks started printing more money than they had gold in stores. This led to people losing faith in the system as a whole.
After 50 years of the UK using gold as a standard for exchange of their currency, France, Germany, and the US adopted it in the 1870s. Until 1914, gold could be exchanged for paper money in fixed quantities.
When the First World War broke out, many nations started printing more money than they had gold in stores. This caused massive devaluation of currencies around the world. There was even a time when people burned wagons of paper money just to stay warm.
In 1928, the gold standard was virtually re-established.
Amidst the Second World War, representatives of 44 nations met in Bretton Woods, New Hampshire, in the US. They agreed to set a new standard for foreign exchange. This was also the meeting that established the International Monetary Fund and the World Bank.
These 44 nations then agreed to peg their local currencies to the US dollar. The US dollar was then pegged on gold at a fixed rate. This meant that the USD became the international standard for foreign exchange.
This, however, also posed problems particularly for the United States.
In 1971, then US President Richard Nixon implemented a series of economic measures to combat the increasing inflation in the country. One of these measures was the unilateral cancellation of the previously agreed standard set in Bretton Woods.
Floating Exchange System
Because of the measures put in place in 1971, the value of currencies is no longer based on gold or anything of value. Instead, the value of these currencies is now determined by the floating exchange rate. This rate is not controlled or influenced by governments. Instead, they are influenced by supply and demand in the foreign exchange market.
The history of the foreign exchange market is closely intertwined with the history of money and economics as a whole. Learning more about this can help when participating in the modern forex market. For more information, reach out to us or read our other blog posts.