The History of Forex Trading

History of forex trading

The forex exchange is one of the financial markets that has changed the most over the course of history. As of the 1990s, access to the foreign exchange market is no longer reserved to large financial institutions, it is open to all investors. In this non-centralized electronic market, the world's currencies are now traded 24 hours a day. What follows is the history of the forex trading.

The origin of money up through the antiquity

Money first appeared in China in 3000 BC; these pieces of metal had various shapes. A distinctive sign that authenticates currency will be used as of around 1530 BC. Around 650 BC, coins shaped as they are today were issued in Lydia (Turkey). They were made of gold and silver alloy. Around 550 BC, the first pure gold and silver coins appeared thanks to advances in metallurgy. In just one century, the use of coins became widespread throughout Greece, followed by Gaul (which would become France) in 450 BC. During this time, each Greek city stamped its currency (silver) with its emblem. During the reign of Alexander the Great (334-324 BC), the King's portrait gradually replaced the symbols engraved on coins until the birth of modern republics.

Exchange letters appear in the Middle Ages

In the 5th century AD up until the middle ages, coins are rarely used outside of kingdoms. In the tenth century, commerce extends to national and European levels. Cultures and therefore currencies therefore meet in areas of exchange. To facilitate payments between countries, letters of exchange were created in 1291 in Florence. They allow for exchange rates and interest rates to be set, and this will generate fortunes for private bankers like the Medici family. Letters of exchange were then traded in the first real market exchange, which was created in Bruges, Belgium in 1409.

Financial markets in Europe in modern times

In the 16th century, international trade was growing quickly and the first financial markets appeared in Europe. In these financial markets, the exchange rates between currencies varied depending on the countries' trade balances. Some traders start to earn profits from the differences in exchange rates. In 1572, regulations got tighter, the goverment, which uses letters of exchange to finance its expenditures, appoints exchange agents.

The use of the gold standard in contemporary times

Until the 19th century, there wasn't really any dominant currency yet. In 1866, the transatlantic cable linking the United States and Europe was a milestone in the history of communication and exchanges between the pound and the dollar. Many foreign banks settle in England, which became the world's first financial center. Exchanges are mainly conducted in British pounds, but gold is still considered to be the most reliable reserve currency, in fact, all currencies are convertible into gold. Each central bank must ensure the convertibility of its currency with gold reserves; this is known as the gold standard. Between 1879 and 1914, exchange rates fluctuate, but they remain stable.

World War I in 1914 put an end to the gold standard. Countries spent considerable sums of money to finance the war and they printed more money than they had. Inflation increased and countries were ultimately forced to suspend the convertibility of their currencies into gold. After the war, the exchange rates were set by the state: France and England adopted high interest rates in order to create stronger currencies.

In 1922, the Genoa agreements implemented the Gold Exchange Standard, which stated that certain currencies may be convertible into gold. Currencies not convertible into gold may in turn be converted into another convertible currency (the franc, the dollar or the British pound).

In 1925, the United Kingdom once again adopted the gold standard. Despite significant post-war inflation, the government implemented a drastic monetary policy to get back to pre-war parity. The increased value of the pound relative to gold leads to deflation of the UK economy. The gold standard was restored in France in 1928.

The economic crisis of 1929 once again puts an end to the gold standard system. In 1931, Great Britain, Germany and Japan abandon the gold standard. In 1933, the United States also abandon the gold standard and, in 1934, they devalue the dollar by 40% compared with gold. France abandoned the convertibility of the franc in 1936. The world is now divided into monetary entities.

The Bretton Woods agreements and the International Monetary System

The second World War of 1939-1945 marked the supremacy of the dollar. In 1944, the Bretton Woods agreements which brought together 44 nations established the first true International Monetary System (IMS) to control currency fluctuations and restore economic stability. This agreement states that only the dollar may be convertible into gold, at a fixed rate of $35 per ounce. At that time, the United States held three-quarters of global gold reserves. The dollar becomes the currency, exchange rates of other currencies become fixed (with a margin of +/- 1%) and linked to the dollar. Central banks were obliged to intervene to maintain the parity of their currency. Currency depreciations between countries became impossible, thereby ensuring the principle of free trade. The IMF (International Monetary Fund) was created in order to regulate the IMS.

During the 1960's, holders of dollars lost confidence in their currency and they asked that their money be convertible into gold. While the U.S. deficit increased, the stock of gold decreased and ended up being lower than that of the dollar. In 1971, the dollar's convertibility was suspended, the central banks no longer supported the dollar, which was devalued several times.

The floating currency market (the forex market)

In 1972, the Basel agreement established the European currency snake. The countries committed to stabilising their currencies with a maximum margin of +/- 2.5%. The dollar's devaluation, which increased between 1972 and 1978, quickly forced most currencies out of the snake.

In 1973, the international monetary system switched to a floating exchange rate. The forex market as we now know it was taking shape. The end of the Bretton Woods monetary system caused an upheaval in the world of finance. Supply and demand, which are influenced by interest rates, determine the exchange rates between currency pairs, which are now backed by public and private debts. From that moment, the creation of money intensified; in addition to no longer being required to maintain their exchange rates, deficit countries could now easily borrow money in the financial markets.

In January 1976, the Jamaica agreements permanently officialized the end of the Bretton Woods agreements. The foreign exchange market became liberalized, there were no more rules overseeing the exchange rates between currencies, gold was no longer a reserve instrument and countries were welcome to adopt a floating exchange rate system. However, three exchange rate systems emerged.

  1. Dollarization: when a country decides to use the currency of another country as their currency.
  2. A stabilised exchange rate: the country decides to link its currency to another currency in a permanent manner.
  3. A managed variable rate: the exchange rate evolves freely according to supply and demand.

In 1979, the European Monetary System was created, which established a common standard referred to as the ECU (the predecessor to the EURO). The agreement specified that central banks be committed to maintaining the exchange rate of their currency within a margin of +/- 2.5% away from the central rate. European currencies were almost stationary amongst themselves, but they varied in relation to global currencies.

In 1985, under pressure from the group of five (United States, Japan, Germany, UK and France) the dollar was devalued.

In 1986, London's deregulated market became a very important financial center.

Forex trading for retail investors (you and me)

In 1990, capital flows between nations increased thanks to new technologies. The forex market, which was previously limited to large financial institutions, became accessible to individual traders and investors, who could now speculate on currencies.

In 1992, we witnessed several crises linked to currency speculation movements. Billionaire George Soros initiated a short position of 10 billion pounds, betting on the decline of that currency. The Bank of England was forced to remove the pound from the European Monetary System. George Soros's profit from that transaction was estimated at one billion dollars.

As of 1995, individual traders can trade currencies in real time through the internet and through forex brokers. Since 2002, general interest in currency trading has been experiencing very strong growth. Online brokerage firms are innovating thanks to their online trading platforms and social networks of traders.

Nowadays, the foreign exchange market is the largest financial market in the world in terms of daily transaction volume, which is estimated at over four trillion dollars.