Today we’d like to take you all on a trip down memory lane and explore the history of the currency market. We hope that this would give you a better understanding of Forex and the founding principles that guide the financial markets.
Back in the day countries could trade with one another using precious metals such as gold and silver. However, how much a country could trade clearly depended on the availability of said metals on its territory, which in many ways could make international trade unfair. More importantly, the discovery of new mines meant the price of the metal would go down globally.
This changed in 1885 when the gold standard was established. The gold standard essentially meant that a country had to tie its currency to the amount of gold it had available. In essence, the central bank couldn’t print more money than there was gold in its reserves. A certain amount of currency was tied to an ounce of gold, and this served as a basis for the exchange rate between the two currencies. For example, if an ounce of gold cost 100 of A but only 10 of B, then 10 A = 1 B, where A and B stand for currencies.
During World War I banks found themselves printing more money than they had gold because they needed funds to finance the war. Military expenses were so vast that the gold available couldn’t pay for them. Though countries tried to stick to the gold standard, it didn’t last long, as World War II followed soon. That is how despite gold’s undisputable value to this day, it’s no longer used as a standard for exchange rates.
The second World War was actually the reason for the Bretton Woods standard to come into existence. The Allies established it as a means to facilitate trade amongst themselves in order to finance their war efforts better. This standard was established worldwide soon enough.
As a result of the agreement, the American dollar became the base currency used in most rates (today major currencies are measured against the Dollar Index). The dollar was supposed to be the only currency backed by gold, therefore adhering to the gold standard from the pre-war era. Fixed exchange rates came to be and a series of international regulatory organizations were established, namely the IMF, the International Bank for Reconstruction and Development, and the General Agreement on Tariffs and Trade (today the World Trade Organization).
The Bretton Woods standard met a lot of trouble. US gold reserves turned out to be insufficient to cover the dollars which banks all over the world had at their disposal. In 1971, US President Richard Nixon made the decision to stop exchanging dollars for gold, which in practice ended the Bretton Woods system.
Even though the two standards we looked at today were imperfect and didn’t last long, they served as important stepping stones to the economies of today. Soon we would continue our journey into the history of the Forex market with more recent developments.
Let us know in the comments below if you enjoy these history articles so that we can prepare more on other topics interesting to you.