History of forex
Forex trading began centuries ago. Diverse currencies, as well as the need to exchange them, has been in existence since the Babylonians. The Babylonians are credited with the first use of paper notes as well as receipts. Several centuries ago, the Greeks and the Egyptians traded goods and currencies with molten silver and gold coins. Their value was determined by their actual weights and sizes.
During the Roman Empire, approximately five hundred years ago, the government at the time centralized the mining of currency with the government placing a monopoly on currency trading. This was the beginning of a centralized monopoly-like structure which still exists today with central banks all over the world deciding and ruling about monetary policies.
Approximately 1000 years ago, during the Middle Ages, copper became a commonly used metal for minting coins and trading. As a result of using copper instead of gold, the creation of lower value coins now became possible. The oldest bank in the world, known as Monte dei Paschi, was established at a time when its only function was to facilitate the transaction of currencies.
Gold exchange standard
Before the First World War, central banks supported their currencies with convertibility to gold. However, there were several weaknesses of boom-bust patterns on the gold exchange standards. This is because the strengthening of an economy meant that large amounts of gold would be required to be imported to ensure that a nation does not run down its gold reserves.
This resulted in the diminishing of money reserves leading to an escalation of interest rates, and consequently, economic activities would slow to the point of recession. This kind of gold exchange was therefore not sustainable because central banks required full coverage of the government’s currency reserves.
To protect national interests, foreign exchange controls were introduced to prevent market forces from being affected by the market forces. This resulted in the abandonment of the gold standard system.
The Bretton Woods System
Before the end of the Second World War, the Allied countries decided to establish a monetary system to fill the void left after the gold standard system was abandoned. In July 1944, representatives from the Allies met in Breton Woods, New Hampshire to discuss the establishment of the Bretton Woods system of the international monetary management.
The meeting at the Bretton Woods led to the establishment of a method of fixed exchange rates. As a result, the US dollar replaced the gold standard to become a primary reserve currency. Three global agencies were also established to oversee economic activity. The agencies are the International Monetary Fund, the General Agreement on Tariffs and Trade (GATT), and the International Bank for Reconstruction and Development.
The US dollar thus became the only currency to be backed by gold all over the world. However, it also became a problem after US gold reserves in the US treasury could not be enough to cover all US dollars which foreign central banks had in reserve.
Consequently, in 1971, the US President Richard Nixon closed the gold window, refusing to exchange US dollars for gold, thus marking the end of Bretton Woods. In as much as the Bretton Woods did not last, it, however, left a major effect since the institutions which were created in the 1940s led to the establishment of the World Trade Organization.
Over the last couple of years, forex trading has developed into a large global forex market. Restrictions on capital flaws were eliminated, a situation which left the market forces free to adjust to foreign exchange rates in accordance to their perceived values.
Initially, the foreign exchange market operated under central banks and government institutions. It however later accommodated other institutions which also comprises of dot.com booms and the World Wide Web. The size of the forex market currently dwarfs any other investment market. It is currently the largest financial market globally. Arguably, it is a very lucrative opportunity for the modern day savvy investor.