The foreign exchange market (forex) is a decentralized, over-the-counter financial market that regulates the trading of currencies worldwide. Around the world, financial centers anchor the trading between different types of buyers and sellers through forex. Foreign exchange market assists in international trading and investment and allows businesses to convert a particular currency into the other. For instance, forex permits a U.S. business house to import European goods and pay in Euro, though the business’ income is in U.S. dollars. This article dwells at length on the origin and history of Forex. Read on to know how it developed into the shape that it has assumed today.
Interesting & Amazing Information On Origin & Background Of Foreign Exchange Market
The beginning of economic transactions was marked by the value of goods being expressed in terms of other goods. The economy functioned on the basis of barter between individual market participants. Soon, metals, gold and silver in particular, were established as an accepted means of payment, as they had a reliable value. With the passage of time, stable political governments introduced paper money, which gained wide acceptance during the Middle Ages. The introduction of currency notes changed the face of economic transactions and gave a boost to trade among nations.
Before the advent of World War I, most of the central banks supported their currencies with gold. Although paper money could be exchanged for gold in almost all types of transactions, this did not occur quite often, giving potency to the notion that there was not necessarily a need for full cover in the central reserves of the government. However, the inflated supply of paper money, without the necessary gold cover, fostered shocking inflation and consequently, resulted in political instability. This necessitated the introduction of foreign exchange controls to restrict the market forces from pushing monetary irresponsibility.
In the later years of World War II, the Bretton Woods Agreement was accepted on the initiative of the United States, precisely in July 1944. This was also the period when other international monetary institutions came into existence, such as IMF, the World Bank and GATT (General Agreement on Tariffs and Trade). A system of fixed exchange rates, which partly reinstated the gold standard, fixing the US dollar at USD35/oz and fixing the other main currencies to the dollar was developed by the Bretton Woods Agreement, which was supposed to be permanent.
Contrary to the common notion, the Bretton Woods system collapsed in the early seventies, following the suspension of gold convertibility in US, by President Nixon. The dollar ceased to be the only suitable international currency, as it was bearing severe pressure due to increasing US budget and trade deficits. In the following decades, foreign exchange trading developed to become the largest global market. Most countries removed restrictions on capital flows, giving the market forces much autonomy in adjusting foreign exchange rates according to their perceived values. Still, the idea of fixed exchange was still very much there.
EEC (European Economic Community) introduced the European Monetary System, a new system of fixed exchange rates, in 1979. This system also suffered severe setbacks in 1992-93 and was followed by a renewed attempt to fix currencies and replace some of them with Euro. Events in South East Asia, in the late part of 1997, also indicated the lack of the sustainability in fixed foreign exchange rates. During this period, many South East Asian currencies were devalued against the U.S. dollar, leaving the whole system of fixed exchange rates very vulnerable. Till date, the currency environment continues to be volatile. However, the size of foreign exchange market is now bigger than any other investment market by a large factor.