History of the FX Market – Origins of FX Trading
Welcome to the forex history. In this, we will explore the origins of the FX market and how FX trading became what it is today. You will learn how money changed, how we adapted, and how the policies written from as early as the end of the First World War, have shaped forex history to bring us here. As you finish doing all this, look through our forex broker reviews to get the FX market's best forex broker.
Forex history is a long and exciting topic that we will attempt to cover in one brief article. At the end of this, you will know where it all started and how we ended up with the $5 trillion-a-day market we have today.
The FX market can be traced back to when the Babylonians roamed the earth as one of the greatest civilizations ever. The act of exchanging fiat currencies is centuries-old for a reason. People have always needed to trade things, but have not always had the same 'currency.'
In FX trading today, we have the biggest and most liquid market available to everyone who needs to use it. It is essential that you, as a forex trader, understand the origins and necessity of this market and how it evolved to become the behemoth it is.
Forex History: It Began With Barter
If you remember your history correctly, then you know that the earliest forms of trade were Barter trade. It is the oldest exchange, and it began in many places around the world. Some of the most well-documented information about forex history starts with the Mesopotamia tribes.
In the barter system, goods were exchanged for goods. It was not like the modern forex market, but it also was like our current markets in the essential aspects. The system evolves, and several high-value goods coveted by all became payment standards.
That is how we ended up with mediums of exchange like salt and spices. The ships of powerful merchants and kingdoms, sailed around the world to far off places to obtain these goods. They became the first pioneers of foreign exchange.
As early as 6 BC, the first gold coins were being made in several places around the world. They became currency. Instead of giving goods to get goods, you could provide gold to obtain products and then exchange the gold for different commodities.
That is how money started to evolve. The gold coins provided:
- Limited supply
With these characteristics, money was born, and the gold coins gained mainstream popularity. They would be the reason for the formation of the first banks in history, and with that, FX trading inched towards its most modern form.
The Gold Standard
Over time, gold coins became the widely accepted form of exchange. However, as the world became more modern, they became impractical because of the weight. Carrying a bag of gold is not easy or practical. So, the Gold Standard became the new thing.
Under this phase of forex history, the early 1900s saw the introduction of countries trading each other, because they figured out how to convert the currencies that they were given, into gold.
Here’s how that worked, in the 1800s, countries decided that the gold standard would guarantee that a government could redeem any amount of paper money, for its value in gold. That is how paper currency was backed by gold.
The system worked well into the 1900s, and then the first World War started, and the European countries were forced to suspend the gold standard to print more money to pay for the war.
The gold standard, faltered when the wars started. It could not hold up and promise the same robust and reliable backing that it had ensured when economies were not busy depleting resources to fund wars.
War is expensive, so governments had to cut corners and imbue paper money with value, backed by nothing, except that people agreed it would be valuable. You could no longer walk into a bank and get gold in exchange for your paper money.
The Introduction of the Bretton Woods System
The modern FX market traces back to the end of World War II when the world was in so much chaos that the major governments in the west decided that they would create a system that would bring stability to the global economy.
It is known as the Bretton Woods System. It is an agreement that set the exchange rate of the US dollar against gold. With that, it was possible for all other currencies in the world, to be pegged against the US dollar.
With this stabilization of rates for a while, the world's significant economies started to change and grow at different rates. After a while, the rules of this system seemed limiting. Forex history remembers this as the time when a change was needed.
By 1971, the Bretton Woods Agreement was scrapped, and, in its place, we got a different currency valuation system.
In studying forex history, we know that the Bretton Woods System failed because the premise stopped working.
The premise had been that they would peg gold to the US Dollar, and after a while, the amount of gold available, was not enough to back the amount of US dollars that were in circulation. The amount of currency in circulation increased due to an increase in government spending and lending.
When Richard Nixon ended it, forex history started into the modern version we have today.
The United States was at the helm of this new system. The FX trading market became free-floating, where supply and demand dictated the exchange rates. At first, it was not easy to come up with fair exchange rates, but with technology getting better, things became more accessible.
The Dawn of an Era of The Free-Floating System
The Smithsonian Agreement is what replaced the Bretton Woods Accord. In December 1971, the free-floating system started, and the currencies had a more significant fluctuation room. The US government pegged the dollar to gold at $38 per ounce, which depreciated the dollar.
In the Smithsonian agreement, other major currencies could fluctuate by 2.25% against the US dollar, and the dollar was pegged to gold.
In 1972, the European community decided to move away from its dependence on the US dollar. They established the European Joint Float, consisting of West Germany, France, Italy, the Netherlands, Belgium, and Luxemburg.
These agreements made the same mistakes made by the Breton Woods Accord and collapsed the very next year, in 1973.
After this failure, forex history would have to be shaped by the official switch to a free-floating system.
The Plaza Accord
What? Did you think we're done with Accords? This is forex history, trader! In the 1980s, the dollar had much appreciated against the other major currencies. This was not easy on exporters, and the US current account ran a deficit of about 3.5% of the GDP.
To respond to the stagflation which began in the early 1980s, Paul Volcker raised the interest rates, causing the dollar to become stronger and decreasing inflation. He did this at the expense of the competitiveness of US industry and global markets.
The weight of the US dollar was crushing the third-world nations under debt, and American factories were closing because they were unable to compete with foreign powers.
In 1985, the five most powerful economies of the G5 (US, Great Britain, France, West Germany, and Japan), sent representatives to a secret meeting at the Plaza Hotel in New York City.
The news of this meeting leaked, and the G5 was forced to make a statement encouraging other currencies' appreciation. It would become known in forex history and finance, as the Plaza Accord.
The fallout from this, made the US dollar fall precipitously. It was not long after this that traders started to realize than an FX market could profit from this newly minted world of currency trading.
Even when the government intervened, there were sharp fluctuations, and as you know in FX trading, where there is fluctuation, people stand to make profits. So, a decade after the collapse of Bretton Woods, forex history was well on its path to form a new and accessible world of currency trading.
When the Euro Became Established
The second world war led to European efforts to consolidate the countries in the region and bring them closer. None of these treaties were more prolific than the 1992 treaty known as the Maastricht treaty.
It was established under the European Union and led to the creation of the Euro currency, which put together many new foreign policy and security initiatives. Throughout forex history, this treaty has been amended several times, but the legacy it creates of the Euro remains.
It gave the European banks and businesses the benefit of eliminating exchange risk in an increasingly globalized economy.
The Dot-Com Age
If it were not for computers, forex history would still be stuck in a very inaccessible place. We would not have the FX market or FX trading as we know it today. However, the internet boom would have happened eventually.
In the 90s, computers came along, and thanks to the advancements made by tech nerds, the internet boomed, and banks started to make their trading platforms.
The platforms were designed to stream out live quotes of the exchange rates to the clients so that they could make the trades themselves. That is how the FX market and FX trading we do today started to form.
Intelligent people with a sense of entrepreneurship started to develop internet-based trading platforms for individual FX trading enthusiasts.
These businesses became retail forex brokers. They made it easy for forex history to finally evolve the FX market in the way that we know it today. FX trading finally took off. Smaller trade sizes were the key, to allow more people to participate.
The interbank forex market at the time had standard sizes of one million units. With retail brokers, individual FX trading could be done for as little as 1000 units. That was a part of forex history that made it possible to do what we do today.
About Retail Forex Brokers
Before the FX market was accessible to you, only bog speculators and investment funds with vast amounts of capital could do FX trading. Thanks to retail forex brokers and the rise of the internet that is not the course that forex history remained in.
With almost no barriers to entry, anyone could contact a broker, open an account, deposit money, and do FX trading from their home. All you needed was what you need today, a computer, a broker, a platform, internet access, and knowledge.
Now, we have two types of broker, as created by the course forex history took:
- The Market Makers- As the name suggests, they 'make' their bid and ask prices. That is what you get when you work with them. They dictate the rates.
- The Electronic Communications Networks (ECN)- This kind uses the best bod and asks for prices from the interbank market (the liquidity pools).
The ECN types are better, but they require a lot of capital for you to get started. They also work on commission, unlike Market Makers, who make their money from the Spreads.
The Market Today
Here's where we end our forex history lesson. We hope you now understand how this came to be and the journey we have had to travel to have the FX market as it is today and enjoy FX trading from the comfort of our homes.
Right now, the FX market is the largest financial market in the world. More than $5 trillion is traded every single day. The future of the FX market is not very clear. The world is ever-changing, the introduction of crypto is a threat to currencies as we know them.
However, there will always be an opportunity for traders. For a forex trader to survive in the market, they need to be always ahead of the developments around them. If there is something new for you to do, learn it.
If you are new, never ever skip the lessons and education. After you are ready to trade and want to get into demos and familiarize yourself with what you have to do, you can read our forex broker reviews to get the best forex broker.
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