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modern foreign exchange market (fx or forex) began
to develop in 1973. However, money has been around
in one form or another since the time of Pharaohs.
The Babylonians are credited with the first use
of paper bills and receipts, but Middle Eastern
moneychangers were the first currency traders
to exchange coins from one culture to another.
During the middle ages, the need for another form
of currency besides coins emerged as the method
of choice. These paper bills represented transferable
third-party payments of funds, making foreign
currency exchange trading much easier for merchants
and traders and causing these regional economies
to flourish.
From the infantile stages of forex during the
middle Ages to WWI, the forex markets were relatively
stable and without much speculative activity.
After WWI, the forex markets became very volatile
and speculative activity increased tenfold. Speculation
in the forex market was not looked on as favorable
by most institutions and the public in general.
The Great Depression and the removal of the gold
standard in 1931 created a serious lull in forex
market activity. From 1931 until 1973, the forex
market went through a series of changes. These
changes greatly affected the global economies
at the time and speculation in the forex markets
during these times was little, if any.
The Bretton Woods Accord
The first major transformation, the Bretton Woods
Accord, occurred near the end of World War II.
The United States, Great Britain and France met
at the United Nations Monetary and Financial Conference
in Bretton Woods, N.H., to design a new global
economic direction. The location was chosen because,
at the time, the U.S. was the only country unscathed
by war. Most of the major European countries were
in shambles. Up until WWII, the British pound
was the major currency by which most currencies
were compared, but that changed when the Nazi
campaign against Britain included a major counterfeiting
effort against its currency. In fact, WWII vaulted
the U.S. dollar, from a failed currency after
the stock market crash of 1929 to benchmark currency,
by which most other international currencies would
become compared and valued. The Bretton Woods
Accord was established to create a stable environment,
leading to an onslaught of other global economies
restoring themselves and their currencies. In
fact, the Bretton Woods Accord established the
pegging of currencies and the International Monetary
Fund (IMF) in hopes of stabilizing the global
economic situation.
Major currencies were now pegged to the U.S.
dollar, fluctuating by one percent on either side
of the set standard against the dollar. When a
currency's exchange rate would approach the limit
on either side of this standard, the respective
central bank would intervene to bring the exchange
rate back into the accepted range. At the same
time, the U.S. dollar was pegged to gold at a
price of $35 per ounce, further bringing stability
to other currencies and world forex situation.
The Bretton Woods Accord lasted until 1971. Ultimately,
it failed, but it did accomplish what its charter
set out to do, which was to reestablish economic
stability in Europe and Japan. The major reason
it failed was because it continued to use a set
standard to fix a currency against a smaller market,
such as gold.
The Beginning of the free-floating system
After the Bretton Woods Accord came the Smithsonian
Agreement in December of 1971. This agreement
was similar to the Bretton Woods Accord, but allowed
for a greater fluctuation band for the currencies.
In 1972, the European community tried to move
away from its dependency on the dollar. The European
Joint Float was established by West Germany, France,
Italy, the Netherlands, Belgium and Luxemburg.
The agreement was similar to the Bretton Woods
Accord, but allowed a greater range of fluctuation
in the currency values.
Both agreements suffered mistakes similar to
the Bretton Woods Accord and, in 1973, collapsed.
The collapses signified the official switch to
the free-floating system. This occurred by default,
as there were no new agreements to take their
place. Governments were now free to peg their
currencies, semi-peg or allow them to freely float.
In 1978, the free-floating system was officially
mandated.
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In a final effort to gain independence from the
dollar, Europe created the European Monetary System
in July of 1978. Like the previous agreements,
it failed in 1993, but what followed was an evolution
from a combination of the EMS and the Bretton
Woods Accord.
Today, the major currencies, such as the U.S.
dollar, Euro, British pound, Swiss franc and the
Japanese yen, move independently from other currencies.
The currencies are traded by anyone who wishes,
including an influx of speculation by banks, hedge
funds, brokerage houses and individuals. Only
on occasion do some of the central banks intervene
to move or attempt to move currencies to their
desired levels. The underlying factor that drives
today's forex markets, however, is supply and
demand. The free-floating system is ideal for
today's forex markets. The supply and demand of
currencies are driven by three factors, including
interest rates and interest rate differentials,
commodities and global trade. The forex market
is the prime market of the world by all which
all others can be considered derivatives (like
futures and options).
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