Foreign Exchange Market History
Foreign exchange (forex) as we know it today is a recent development. From 1944 to 1971, international currency exchange rates were pegged to the U.S. dollar and regulated by an agreement signed by 44 countries at Bretton Woods, New Hampshire. After the United States pulled out of that agreement, in 1971, most countries moved to floating exchange rates, thus creating demand for foreign currency exchanges. (See Reference 1)
Other People Are Reading
-
Early Currency Use
-
In ancient times, trade was based on barter at the community level, with no need for currency. The first evidence of international commerce involving currency and credit appears around the fourth century B.C. (See Reference 2) Currencies took their value from specific goods backing them without reference to another countries' currency. Gradually, gold became the standard commodity used to back currencies used in international trade.
Modern History
-
Bretton Woods marked the beginning of the end for the gold standard. Instead of gold, the U.S. dollar was chosen as the international "reserve currency." Participating countries agreed to peg their currencies to the U.S. dollar. In turn the United States agreed to back each dollar with one-thirty-fifth of an ounce of gold. That agreement broke down in 1971 when the United States allowed the dollar's value to float relative to gold. Other countries soon abandoned the agreement, and markets sprang up to buy and sell free floating currencies.
-
Misconception
-
There is a common misconception that a central exchange exists where official rates are established and published. As international banks and merchants began doing business in a world of floating currency values, entrepreneurs stepped in to create numerous independent currency markets. They offer to buy at one rate and sell at another, the difference (spread) being their gross profit. Before the Internet age, business was done by telephone with spreads negotiated based on amount exchanged and status as a customer.
Regulation
-
Foreign exchange markets and brokers are not regulated like stock exchanges and stockbrokers. Government regulation has emerged since 2000, but remains limited. Capitalization requirements came about in the United States only after many clients were left holding the bag when unscrupulous brokers closed up shop without notice. The Commodity Futures Modernization Act of 2000 gave the U.S. Commodity Futures Trading Commission some authority over foreign exchange firms. Since then, capital requirements have gradually escalated from zero to $20 million. (See Reference 3)
Benefits
-
The history of forex markets since 1971 is a classic example of a free market in action. Competitive forces have created a marketplace with unparalleled liquidity. Spreads have fallen dramatically with increased online competition among trustworthy participants. Individuals trading large amounts now have access to the same electronic communications networks (ECNs) used by international banks and merchants. Smaller traders can choose from a number of brokers with long track records and solid reputations.
Warning
-
No matter how good your broker or ECN, forex trading is extremely risky. Never invest more than you can afford to lose. Don't trade unless you fully understand the risk inherent in leverage.
-
References
Resources
- Photo Credit Steve Wood/Public Domain Screen Capture
