Forex Market History

An Overview Into the Historical Evolution of the Foreign Exchange Market

From the days of the gold exchange, through the the Bretton Woods Agreement until present day, this article will follow the historical roots of the international currecny trade to its current setting today
The Gold Exchange Period and the Bretton Woods Agreement
The Bretton Woods Agreement, established in 1944, fixed national currencies against the dollar, and set the dollar at a rate of $35 per ounce of gold. In 1967, a Chicago bank refused a college professor by the name of Milton Friedman a loan in pound sterling because he had intended to use the funds to short the British currency. The bank's refusal to grant the loan was due to the Bretton Woods.

The Bretton Woods Agreement, set up in 1944, aimed at setting up international monetary steadiness by preventing money from taking flight across countries, and curbing conjecture in the international currencies. Prior to Bretton Woods, the gold exchange standard -- paramount between 1876 and World War I -- ruled by superior authority over the international economic system. Under the gold exchange, currencies gained a new era of stability because they were supported by the price of gold.

However, the gold exchange standard had its weaknesses of boom-bust patterns. As an economy strengthened, it would import a great deal from out of the country until it ran down its gold reserves required to support its money; as a result, the money supply would diminish, interest rates escalate and economic activity slowed to the point of recession. Ultimately, prices of commodities had hit bottom, appearing attractive to other nations, who would sprint into buying fury that injected the economy with gold until it increased its money supply, drive down interest rates and restore wealth into the economy. Such boom-bust patterns abounded throughout the gold standard until World War I temporarily discontinued trade flows and the free movement of gold.

The Bretton Woods Agreement was founded after World War II, in order to stabilize and regulate the international forex market. Participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar and an equivalent rate of gold as needed. The dollar has gained a premium (reference) currency position, reflecting the shift in the global economic dominance from Europe to the USA. Countries were prohibited from devaluing their currencies to their trade advantage and were only allowed to do so for devaluations of less than 10%. The great volume of international forex trade led to massive movements of capital generated by post-war construction during the 1950s, and this destabilized foreign exchange rates as established in Bretton Woods.

1971 heralded the abandonment of the Bretton Woods such that the US dollar would no longer be exchangeable into gold. By 1973, the forces of supply and demand controlled major industrialized nations' currencies, which now floated more freely across nations. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, and new financial instruments, market deregulation and trade liberalization emerged.
The initiation of computers and technology in the 1980s picked up the pace to extend the market continuum in cross-border capital movements through Asian, European and American time zones. Transactions in foreign exchange increased intensively from nearly $70 billion a day in the 1980s, to more than $1.5 trillion a day two decades later.

The Explosion of the Euromarket

The rapid development of the Euro-Dollar market; where US dollars are deposited in banks outside the US was a major mechanism to the speeding up of Forex trading. Likewise, Euromarkets are those where assets are deposited outside the currency of origin. The Eurodollar market first came into being in the 1950s when Russia's oil revenue -- all in dollars -- was deposited outside the US in fear of being frozen by US regulators. That gave rise to a vast offshore pool of dollars outside the control of US authorities. The US government imposed laws to restrict dollar lending to foreigners. Euromarkets were particularly attractive because they had far less regulations and offered higher yields. From the late 1980s onwards, US companies began to borrow offshore, finding Euromarkets a beneficial center for holding excess liquidity, providing short-term loans and financing imports and exports.

London was, and remains the principal offshore market. In the 1980s, it became the key center in the Eurodollar market when British banks began lending dollars as an alternative to pounds in order to maintain their leading position in global finance. London's convenient geographical location (operating during Asian and American markets) is also instrumental in preserving its dominance in the Euromarket.