This article looks at the history of the foreign exchange rates.
Bearing in mind the international nature of the forex market, you should be aware of some of the historical events before you commence trading. The international monetary systems have evolved over the years and you need to understand who the major players in this market are.
The History of the Foreign Exchange Rates
Gold Standard System
This monetary system during 1875 was an important event in the history of the foreign exchange market. Prior to the implementation of this standard, countries used to use silver and gold as a means of payment to each other. The problem that was encountered with this system is that both these resources were affected by supply and demand. An example is that whenever a new gold mine was discovered, the gold price would take a dive.
The main idea for this system was that different countries guaranteed currency conversion into a specified amount of gold. This required the governments to hold huge deposits of gold to meet these currency exchanges. By the late 19th Century, all the major countries came to an agreement regarding the value of a currency to one ounce of gold. With time, the variance in the price of one ounce of gold between two currencies would become the exchange for those particular currencies. This was the first currency exchange method in history.
During the First World War, this standard of currency valuation broke down. The political tension involving Germany caused all the main European powers to undertake huge military projects. These projects caused a huge burden on the countries and they found themselves in a situation where they were unable to guarantee the amount of gold to justify the amounts of money the governments were printing.
The gold standard made a tiny comeback during the years between the world wars, but most countries decided to drop it by the time World War Two commenced. Gold has never ceased to be the most highly rated from of value in the monetary world.
Prior to the end of the Second World War, the Allied nations decided that a new monetary system was required to replace the gold standard system. During 1944 a number of Allied representatives gathered at Bretton Woods, New Hampshire, to discuss the new system. This was the introduction of the Bretton Woods system of money management internationally.
The Bretton Woods system was responsible for:
- Introducing a system of fixed foreign exchange rates
- Introducing three agencies to vet economic activity internationally. These are the International Monetary Fund, the General Agreement on Tariffs and Trade, and the International Bank for Reconstruction and Development
- The US dollar becoming the primary reserve currency, thus replacing the gold standard
One of the most important decisions made at Bretton Woods was that gold was replaced by the US dollar as the standard of conversion for international currencies. Along with this, the US dollar was to become the only currency that would still be guaranteed by gold.
During the two decades or so after the introduction of Bretton Woods, the US was forced to undergo a deficit in their balance of payments simply to remain the reserve currency. By the 1970s, the gold reserves of the US were so low that the US treasury was unable to cover the US dollars held by foreign banks. It was during 1971 that the US finally shut down this system and declared that the US would no longer exchange US dollars for gold that was being held in foreign reserves. This was the end of this particular system.