The History of Forex Trading

Posted by forex on August 19th, 2010

History of forex trading traces back to Babylonian times. Existence of Different currencies and necessity of exchanging them existed at that time. Use of the paper currency was first introduced at that time.

During the old age, value of goods was evaluated in terms of other goods. This system is called ?Barter System?. However, ?Barter System? has many limitations, this lead to evolve generally acceptable mediums of exchange. It was necessary that base value of the goods or service should be determined. Metals, particularly gold and silver were accepted as a medium of exchange for goods and services. Many countries of Asia and Africa have a long history of using metals as a medium of exchange. Later on, stable political regimes introduced coins as a medium of exchange. However during the middle age, paper money was introduced by several countries as a medium of exchange.

Gold Exchange Standard System

The main concept of paper money was that it was supported by gold or silver. The holder of paper money could convert it immediately to gold. People?s faith in paper money grew. From 1870 to the end of WWI, 1918, gold exchange standard ruled over the international economy, because it was supported by the value of gold, currencies experienced stability under gold standard system. However gold standard system had many weaknesses. Boom-bust economic pattern is the key weakness of gold standard system. Insufficient gold reserves are creating instability in country and devaluation of currency and commodities. Before WWI, the volume of trade in the forex markets was very small, and market remained stable. However after WWI, forex market became highly volatile and volume of trade increased manifold. From 1931 to 1973, forex markets experienced series of changes. These changes laid foundation of the modern forex market.

The Bretton Woods Agreement

In the year 1944, representatives from 44 nations in New Hampshire, fixed national currencies against the US dollar, and decided the dollar rate of per ounce of gold. Main objective of this agreement was to curtail the economic instability of the countries caused due to the boom-bust pattern of gold exchange standard system. On the international trading front, purpose of this agreement was to prevent speculation in the international currency market and providing economic stability. The participating nations agreed to maintain the thin margin of their currency value against US dollar, and the same rate of gold as required. Participating countries were not allowed to devalue their currency to benefit in the foreign trade. This made US dollar standard currency, which was exchangeable with gold. It was a calculated move which shifted international economic power from Europe to the United States. The policies set by the Bretton Woods agreement could not last long. After WWII, because of prosperity, huge trading volume of the global forex market resulted into large movements of capital, causing destabilization of foreign exchange rates in Bretton Woods Agreement. A new system was required to answer the growth.

The Free Floating System

In the year 1971, international community abandoned Bretton Woods Agreement. By the year 1973, Currencies of all leading nations were floated freely and trading borders were abolished. Forex trade increased and became a large institution in the international financial market. This resulted into increased trade volume and volatility. New financial instruments came into existence and loose trade restrictions and market deregulation emerged. After failing to monitor the forex market, The European Joint Float, was formed to reduce Europe?s dependence on US dollar. After the Smithsonian Agreement, free floating system became official.