Forex trading is a simultaneously new and very old field. It is new in the sense that modern Forex as we know it today had its start in 1973, just a few decades ago. It is old in the sense that trading between different currencies has been going on for millenniums. We’ll examine the historical roots here.
Ancient History
Currency goes back at least to the time of the Pharaohs, where gold coins were traded by various merchants as they went from country to country. An ancient reference to Forex trading can be found in the Talmudic writings. In the Jewish temple, money changers would charge exorbitant fees to trade into the specific coinage accepted by the temple. In today’s terms, their spread was very high.
The Gold Standard
Ancient currency was tied to gold or silver. If a particular country’s gold coin had more precious metal content, it could buy more goods. The vast majority of today’s currencies were at one point tied to gold or silver, with the issuing country backing the paper with tangible reserves of precious metals. In 1816, the British pound was defined as 123.27 grains of gold. This kept the British pound stable since it was backed by a clearly specified reserve. Later, with the outbreak of the First World War, Europe abandoned the gold standard as they had need to engage in military projects that a gold-backed economy would not allow.
The Bretton Woods System
By the end of WW II the Allies believed that a new standard needed to be established. In 1944, they met at Bretton Woods, New Hampshire to iron out how they would accomplish this. As a direct result, the US dollar replaced gold as the primary reserve currency. Other currencies were tied to it with fixed exchange rates. But this led to problems, as investopedia.com summarizes:
Over the next 25 or so years, the U.S. had to run a series of balance of payment deficits in order to be the world’s reserved currency. By the early 1970s, U.S. gold reserves were so depleted that the U.S. treasury did not have enough gold to cover all the U.S. dollars that foreign central banks had in reserve.
This led to a series of economic crises that finally led up to a suspension of the Bretton Woods system, and an end to the tying of the US dollar to the gold standard. In 1971, greater fluctuation was allowed between world currencies as defined by the Smithsonian Agreement, and later, the European Joint Float was established. Both of these failed, and by the end of 1973, the free floating system was the de facto standard, and this was mandated in 1978 by the IMF. All countries now allowed their currencies to be pegged to another currency, or to freely float.
The Internet
1994 saw the first online currency trade, and it has increased dramatically since. Fxinfo.com summarizes the effect this had:
The big change in Forex history is that now anyone could participate and invest in the market. The vast amount of people trading online Forex is due mostly to the option of margin investments that are available with online Forex trading.
One difference between the stock market and the foreign exchange market has to do with access. Large commercial banks and securities dealers make up what is known as the interbank market. The large volumes they deal with allow for very small spreads between the bid and ask prices – spreads any individual investor can only dream of obtaining.
Individual retail speculators – you and I – account for a growing percentage of the total Forex market. This has unfortunately led to a number of foreign exchange fraud cases. It is therefore important that the broker you choose is registered with either the Commodity Futures Trading Commission or the National Futures Association.
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