History of Forex

The History of Forex
The Forex trading market is a relatively new phenomenon. Never before in the history of the world have we seen such an amazing event. In only 30 years, this industry has developed from almost nothing to a daily US$1.5 trillion market. How did this happen? Was it by design? Or was it by accident?Well the answer falls somewhere in between. There are three distinct time frames that set the stage for today's style of currency trading. The first time frame is the pre-currency trading era of the 1950s. The second time frame is the worldwide, politically volatile atmosphere of the 1970s. The third time frame is what has occurred in this free market economy since the demise of the gold standard 30 years ago. In each time frame, there have been three catalysts: war, gold, and foreign banks- that have played a significant role in propelling currency development.
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Pre-Currency Trading Era – The 1950s
Entering into the 1950s, the United States of America had a distinct advantage over war-torn Europe. While Germany was heavily sanctioned, England, France, Italy, and several other Old World nations were just coming to terms with the heavy investment needed to rebuild their countries.As a way to make it easier for the rest of the world to rebuild, the Bretton Woods Agreement was adopted. It was innocuously simple: in an effort to keep the United States of America (USA) from buying everything in sight, the Bretton Woods Agreement kept the USA in check by requiring all foreign currencies be pegged to the US Dollar. Some pegs were strong, some pegs were weak, but at the end of the day they never moved more than 1% in any direction. Like today's problem with the Chinese Yuan, forced to a peg against the dollar, it kept a constant, controlled flow of US dollars out of the country.The peg would not have been so bad if not for the fact that the US dollar also had a unique relationship with gold. Just like currencies, gold was pegged to the dollar at a fixed value of US$35/ounce. What made it even worse was that US currency, at the time, was directly exchangeable for gold. This strategy was fine as long as the Fort Knox gold reserves exceeded $23 billion.After World War II, the USA became the primary economic super power. Many foreign countries began to acquire US currency in lieu of gold. The dollar gained prominence in a way no other currency ever had before.At the same time, we began to see the rebuilding of the Old World and foreign trade began to gain momentum. In 1950, foreign countries held US $8 billion. We also saw the oil business begin its ascent as a prominent import/export industry.
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The 1970's United States Currency Policy Meltdown
Once again, we are hit with the triumvirate of war, the restrictive gold standard, and dollars in foreign banks.This time, each problem was feeding directly off of the others. The Vietnam Conflict had drained our gold reserves heavily. By 1970, Fort Knox only held US$12 Billion.The growth of the oil business and the increase in foreign trade caused a boom in the demand for US dollars in foreign banks. Over US$ 47 Billion was sitting in overseas banks.On paper, our gold reserves were over-leveraged by almost 4 to 1. As a nation, we did not know how to react to such an overbearing assault on our currency. Then along came the invention of the Eurodollar to make our nightmare worse.Foreign banks with US dollars would make low-interest loans in US dollars to importers and exporters. Although the dollars were never repatriated, the US was still on the hook to exchange these “credit”-created dollars for the gold we kept on reserve.Then came a miracle in disguise . The Bretton Woods Agreement collapsed. In the over-leveraged gold-dollar environment, many countries began to feel frustrated with the artificial peg.In blatant defiance to the agreement in 1971, Germany declared that they would float the Deutsche mark. They were tired of the artificial peg that was keeping their economy depressed.In the first hour of trading, over US$1 billion were exchanged for Deutsche marks. For the first time, the public had voiced their opinion against being so heavily weighted with dollars.With Germany completely ignoring the Bretton Woods Agreement by floating their currency, the US government had nothing left to do but put the final nail in the coffin of the U.S.'s currency policy. The Bretton Woods Agreement was dissolved.Three short months after the Deutsche mark began to float, the US moved off of the gold standard. Gold was allowed to float freely like any other currency. Oil, although priced in US dollars, soon switched to a peg against gold. Gold and oil prices jumped ten-fold.The currency dynamics were soon changed on a global scale and it became accepted practice that countries began to float their own currency.
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New Rules of Currency
In 1971, the Smithsonian Agreement replaced the Bretton Woods Agreement and authorized “forward currency contracts”, adding validity to the Eurodollar phenomenon. It didn’t work. A year later the European Joint Float was established. It, and the Smithsonian Agreement, were scrapped in 1973. Even though they were dissolved the concept of “forward currency contracts” stayed as part of the banking system.Once currencies began to “free-float”, they immediately moved away from their gentlemanly 1% fluctuations on either side to huge price ranges, going anywhere from 20-25% daily.From 1970-1973, the total foreign exchange volume went from US$25 Billion to US$100 Billion. With oil prices up, gold prices up, and an economy still reeling from the rapid currency shift, “stagflation”, rising inflation while real incomes remained the same, soon hit the United States.
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Today's Currency World
In the 30 years since the collapse of the last gentlemanly agreement on currency rates, many momentous events have occurred that have affected currencies worldwide. The Japanese yen gained prominence because of Japan's heavy export relationship with the United States. The USSR collapsed. We have had several undeclared wars, the south Asian economies have risen and collapsed, and several investor bubbles have come and gone.Each time, currencies have come away with a newly earned respect by the masses. There has also been a constant element of surprise that keeps you guessing what's next.Current conditions, such as the United States' perpetual war on “terror”, the permanent introduction and dominance of the euro currency, the steady O.P.E.C. increases in oil prices, and gold's renaissance as a store of value, will likely have a tremendous impact on the future of what it means to trade currencies.This could be a fundamental shift in the next phase of currency development.
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