History of Foreign Currency Exchange
Foreign exchange, commonly known as FX, is the process whereby the currency of one country is traded for that of another. This process is necessary for international trade and has been around as long as countries with different currencies have been doing business together. While it could be said that currencies have been exchanged since biblical times, in his book "The Foreign Exchange and Money Markets Guide," author Julian Walmsley dates the process as starting around the time of the Industrial Revolution, stating that "a formal global market for foreign exchange did not develop until the 1800s with cable transfers taking place between London and New York."
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History
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FX trading history can be traced to 1875, with the development of the gold standard monetary system. Prior to this, countries had primarily used gold and silver to make international payments. This was particularly problematic when external factors devalued the gold and silver. The mission of this system was to guarantee any currency, to a set amount of gold. This system broke down due to the political instability of World War I and was not replaced until 1944 when the Bretton Woods system was introduced, with the U.S. dollar as the ultimate exchange currency. This system lasted until 1971, when the current FX system was created.
Value
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The value of one currency in comparison to another is determined by the international exchange rate and is subject to fluctuations based on open trading of currency in foreign exchange markets. To improve their own country's trade position, governments attempted to set exchange rates. This led to trade wars, and the practice of floating currencies was implemented in the 1970s. By floating currencies, the exchange rates are determined by supply and demand. However, countries can still influence rates by selling their gold and currency reserves or buying those of another country.
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Market
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FX is not centralized, and there are thousands of traders worldwide buying and selling currencies. In addition to governments that must closely watch the market and trade currency accordingly, commercial banks, investment brokers, importers and exporters also work the market on a daily basis.
Banks
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The largest traders on the FX are commercial banks, which serve as intermediaries between currency buyers and sellers. Banks will closely watch movements in rates to try to profit from such moves. The results of this trading will be reflected in the exchange rates offered to individuals exchanging one currency to another for trips abroad.
Factors
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The value of a particular currency can be influenced by wide-ranging factors that increase the demand for that currency and, thus, its worth. Common factors include increase in exports and an increase in exchange rates. Any instability in a country will decrease its value. This often includes political instability, which is particularly interesting to watch during the election of top-ranking world leaders, such as the president of the United States and the British prime minister.
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References
Resources
- Photo Credit foreign currency image by timur1970 from Fotolia.com
