Legalized globally, forex trading involves the exchange of various world currencies and financial instruments. These instruments are believed to have been in existence for centuries. We can trace its origins back to the Babylonian period, when commerce through the barter system served as a method of exchange.
Forex trading is generally believed to have originated in Amsterdam approximately 500 years ago and subsequently expanded globally. The forex market is currently one of the most accessible, liquid, and expansive trading markets on a global scale.
The barter system, gold coin standard, Bretton Woods Monetary Conference, and the floating method were among the critical global events that shaped the industry, which had undergone numerous significant shifts in the past. In this article, we share insight into the evolution of the forex market.
Evolution of the Forex Market
Barter System
Mesopotamian tribes devised the barter system, the first method of exchange, in 6000 BC. They employed the system to trade goods via ship, and as the system expanded, salt and seasonings became the most prevalent forms of exchange.
The Babylonians and the Phoenicians in the eastern Mediterranean extended the practice of bartering, and it continued to proliferate. In the sixth century BC, the commerce system underwent the most significant transformation with the introduction of gold coins, which had been in use for thousands of years.
The use of metal-based currencies in international trade was impeded by the absence of a standardised method for determining their value. One solution was to utilise coins produced by a single, reputable issuer. The Aegina "Sea Turtle" coin, a Greek silver piece manufactured on a small island off Greece's coast, was the first currency widely recognized for international commerce.
13th-18th century
In the 13th century, the Republic of Florence emerged as a substantial European and Mediterranean power. Florence produced gold and silver coinage from 1252 to 1533. The "Florin," a gold coin, had a predetermined gold content.
However, the proportion of gold in the coins of other European countries underwent a change when they began minting their own gold coins following Florence. Europe used the Florin as the standard currency for foreign commerce and to determine the international value of other coins.
In the 15th century, the Medici family of the Republic of Florence established the Medici Bank, which rose to become the most prominent bank in Europe during that era. The Medici Bank introduced the "nostro" account book to facilitate trade. This book consisted of two-column entries that displayed quantities in both local and foreign currencies, thereby encouraging forex trading.
Around 2500 years ago, the Greeks and Egyptians used molten silver and gold coins to exchange goods and currencies. The precise weights and dimensions of these coins determined their value. A government-run monopoly on money transactions was established when currency minting was institutionalised 500 years later under the Roman Empire. Today, a centralised monopoly-like system remains in force, with central banks responsible for the implementation of monetary policy.
During the Middle Ages, copper was the most frequently used metal for coin minting and commerce. Therefore, substituting copper for gold allowed for the production of coins with a lower value. 97.5% zinc and 2.5% copper make up the one-cent coins currently in circulation in the United States.
Standard Gold Coins
Most nations implemented the gold standard at the end of the 18th century. Until the outbreak of the First World War, the gold standard ensured that the government would exchange any quantity of paper money for the equivalent value of gold. European countries had to suspend the gold standard and increase the production of paper money to finance the war. Consequently, the necessity for each nation to establish their own fiat currencies emerged at this juncture.
Amsterdam established the initial forex market approximately five centuries ago. The stabilisation of currency exchange rates was facilitated by the freedom to trade currencies. Amsterdam was the birthplace of worldwide forex trading.
The Gold Standard came into effect in 1875. The Gold Standard restricted a nation's ability to produce national currency to the extent of its gold reserves. The design of the Gold Standard was to ensure the value of a currency. The need for countries to print additional currency to cover their expenditures after World War I signalled the end of the Gold Standard.
By 1913, the number of currency trading companies in London had increased from three to 71 in less than a decade. Pound Sterling comprised fifty percent of all foreign transactions. The Pound Sterling was the fourth most transacted currency in 2013, following the US dollar, Euro, and Japanese yen.
The Bretton Woods Monetary Conference
The Bretton Woods Monetary Conference was one of history's most significant events that contributed to the standardization of the forex market as we know it today.
The United States, Great Britain, and France convened at the United Nations Monetary and Financial Conference in Bretton Woods following World War II to establish a new global economic order. The conflict did not significantly impact the United States at the time, leading to its selection as the location. During this period, the majority of the main European countries were in a state of disarray. Following the 1929 stock market collapse, the US dollar transformed from a failing currency to a benchmark that other international currencies would subsequently compare to during World War I.
Consequently, the relative exchange rate of the US dollar to its domestic currency compelled other nations to establish their own exchange rates. However, the US dollar was unable to subdue gold, as it possessed the most considerable reserves on a global scale. In order to achieve this, they prioritised gold over the dollar exchange rate. The introduction of a free-floating system would result in the dollar serving as the standard unit of exchange.
Free-Floating System
The Bretton Woods Accord's opposition to the dollar's dominance led to the establishment of the Smithsonian Agreement in December 1971. This session allowed the currencies to fluctuate within a wider range. The United States depreciated the dollar by offering it to gold at an exchange rate of $38 per ounce. The Smithsonian agreement allows for a 2.25% fluctuation in the value of other main currencies in relation to the US dollar. A pair of gold coins accompany the United States dollar.
George Soros GBP and the Euro
In 1979, European nations implemented the Exchange Rate Mechanism (ERM), which mandated that member countries preserve a consistent exchange rate for their currencies. In October 1990, Britain became a member of this system. In contrast, the British Government had to raise interest rates to 15% to maintain the value of the British Pound and its currency within the agreed-upon range.
Ultimately, the pound's value diminishes in 1992 as a consequence of the inefficiency of maintaining it within the ERM. Currency speculators, like George Soros, earned billions by selling the pound. One of the greatest currency transactions in history is Soros' trade against the British pound. There has been a substantial quantity of discussion regarding the extent to which speculators, such as Soros, either contributed to the currency's depreciation or simply benefitted from an inevitable decline.
Furthermore, the incident was significant because it was the first time that numerous individuals had encountered currency speculation. Twelve European nations participated in the operationalisation of the Euro on January 1, 1999, following a decade of preparation. Coins and banknotes were introduced on January 1, 2002, marking the most significant currency transition in history, replacing twelve previous currencies. At present, the EUR/USD currency pair is the most liquid and extensively transacted of all currency pairings in the forex market.
The Plaza Accord
The dollar experienced a significant increase in value in comparison to other main currencies during the early 1980s. This adversely affected exporters, leading to an increase in the United States' current account deficit to 3.5% of GDP.
Paul Volcker, the governor of the Federal Reserve during the early 1980s, responded to the stagflation that had erupted by increasing interest rates. This led to a decrease in inflation and a rise in the US dollar, which harmed the US industry's competitiveness in the global market.
The weight of the US dollar was crushing third-world nations under debt and forcing American factories to shut down because they couldn't compete with foreign rivals.
The G5 countries, which included the United States, Britain, France, West Germany, and Japan, dispatched representatives to a clandestine meeting at the Plaza Hotel in New York City in 1985.
Information about the meeting leaked, forcing the G5 to issue a statement justifying the appreciation of non-dollar currencies. The dollar's value rapidly declined as a result of this agreement, nicknamed the "Plaza Accord."
Traders quickly recognized the potential for profit in this new realm of currency trading. Despite government intervention, there were still significant levels of fluctuation. And where there is fluctuation, there is potential for profit.
Establishment of the Euro (Maastricht Treaty, 1992)
Following World War II, Europe established numerous covenants aimed at promoting greater cooperation among the region's countries. No treaty was more prolific than the Maastricht Treaty of 1992.
The treaty created the European Union (EU), which resulted in the establishment of the euro currency and formed a cohesive entity that encompassed initiatives on foreign policy and security.
Despite the fact that the treaty has been amended on numerous occasions, the euro's establishment provided European banks and businesses with the unique advantage of eliminating exchange risk in a progressively globalised economy.
In 1996, online trading was introduced.
The 1990s saw a significant increase in the sophistication and speed of currency markets as a result of the alterations in the way people viewed and used money.
With the simple press of a button, an individual who is alone at home can obtain an accurate price that would have necessitated an army of traders, brokers, and telephones just a few years ago.
These advancements in communication occurred during a period when capitalism and globalization replaced previous divisions (such as the fall of the Berlin Wall and the Soviet Union).
In the realm of currencies, everything changed. Totalitarian political systems no longer prohibited the trading of currencies. Southeast Asia's emerging markets experienced significant growth, which attracted capital and fuelled currency speculation.
Forex Trading Today
One of the largest markets in the globe is the forex market is one of the world's largest markets. A classic illustration of a free market in action.
Competitive forces have established a marketplace with extremely high liquidity. With an increase in online competition among participants, spreads have experienced a significant decline.
Individuals who trade substantial amounts now have access to the same electronic communications networks used by international institutions and traders.
The internet's arrival would result in forex trading spreading rapidly across numerous countries. Providing the requisite liquidity to facilitate the exchange and trading of multiple currencies, the banks played a significant role in the standardisation of the current forex market.
Subsequently, the necessity for digital financial intermediaries to connect individuals to the Forex market emerged in order to facilitate forex trading without the necessity of physically visiting a bank to place an order. Brokers are currently responsible for filling this void. Today, an individual can access the global foreign exchange market by establishing a trading account with any broker using their smartphone.
