The Forex Past, Present and Future
The History of Currency Trading
The Forex online market was established in 1971, though it was only possible through a combination of technological, communicational and political advances. Understanding them and how they impact the trading of foreign currencies is a crucial element in becoming a successful, smart, trader. It is important to know that should there be a major event with any of these factors, currencies will be affected - on either side of the profit line. The goal of every trader should be to understand the market, to know what all the statistics mean and how major news can swing a countries currency by making it stronger or diluting its value.
The idea of a foreign currency exchange dates back to the Middle Ages when the first paper money was introduced and represented a transferable payments for merchants and traders - like an I.O.U.-a promissory note. National governments, provinces and municipalities began storing gold, silver and other items of value and issued promissory notes against a set value. The problem was that on any given day that value could change based solely on the decisions of the kings and governors.
Up until the end of World War I (WWI), the Forex markets were relatively inactive and remained stable. However, after WWI the volatility of the Forex market greatly increased and investor speculation grew. From the mid 1870s until shortly after WWI, the international currency systems ran off the principles of the gold exchange model. As a result of being supported by the hard value of gold, paper money, currencies as they became known as, experienced a healthy life under this gold standard.(The term commonly used to describe a value of currency in direct relationship to a the price of a fixed weight of gold). The gold standard helped put an end to the practice of monarchs and dictators of indiscriminately degrading money, which was and still is a major trigger of inflation.
However, as much of a step-up for currency stability as it was, the gold standard had many problems as the industrial revolution advanced. The primary problem was the patterns that would see the constant redistribution of wealth within the world's countries. The peaks and valleys that many of these countries experienced was due, in large part, to the economic instability caused by a lack of gold reserves and a devaluation of other commodities.
Recession was not kind to many of the early speculators; some believe that it was because of this high level of speculation and guesswork which ultimately brought about the the Great Depression. And as a result of what was a very difficult period, people began learning the lessons needed to progress. Policymakers and politicians realized the weight of the currency markets on world finance and in 1931 a period of redefining the Forex and monetary policy began.
Bretton Woods Agreement
The Bretton Woods Agreement, was designed to bring stability to the monetary system and restrict speculation in the world currencies.
As an economy strengthened, imports would increase. This action depleted he reserves of gold required to cover the valuation of its money. This caused the money supply to constrict, interest rates would rise and economic activity could slow to the extent of recession - (a period defined by 3 straight fiscal quarters of gross domestic product losses - in which unemployment and low consumer spending are high). Eventually, the prices of goods had to define a bottom and become palatable to other countries. These countries would start buying the currency en masse, injecting the economy with significant amounts of gold, enough to lead to an increase in the money supply. This drove interest rates down and helped to create wealth within the economy.
This was a pattern that was relived over and again through history until the outbreak of World War I practically closed trading routes and the free exchange of gold and silver. This of course was followed by ‘The Great Depression’, which quite arguably was ended by World War II.
After the Second World War, the Bretton Woods Agreement was established., Participating countries agreed to try and maintain the value of their currency with a small margin against the US dollar, economically, the largest country, and a corresponding rate of gold. Governments were not allowed, under the agreement, to devalue their currency in order to bring on an advantage in trade. If absolutely necessary, they were allowed to play with their valuations as long as it did not cause more than a 10% change. Throughout the 1950s, the increase in global trade brought on massive capital transfers created by post-WWII construction. This caused foreign exchange rates under the Bretton Woods agreement to become unstable.
By 1971, the global situation had inevitably caused a move away from Bretton Woods. US President, Richard Nixon had taken the dollar off the gold standard in order to be able to print more money to fund the Vietnam War. This marked a change in government policy in which a debt/credit system was born. By 1973, the currencies of major industrialized nations became free floating, and in part became more subject to the prices set for them in the Forex market. Prices fluctuated each day, with trading volumes and price volatility increasing throughout the 1970s IT was these drastic changes that gave rise to new financial instruments, market liberalization and deregulation.
With the growth in the telecommunication and computer industries in the early 1980’s, the global financial markets surged and the world grew smaller. All markets became accessible to everyone, no matter what time zone, no matter what time of day.
Transactions in the Forex market increased from about $68 billion per day in the early 1980s, to over $3 trillion a day in 2006.
The Forex Market Today
There have been many factors that have led to the current structure of the Forex market.
Since the early 1970s the Forex market has grown in size, structure, and changed the way it operates. These transformation resulted from changes in the global financial systems. A primary cause of the increase in foreign exchange trading was the rapid development of the Euro-Dollar market, where US dollars are deposited into central and local banks outside of the United States. Similarly, it is typical for countries within the European markets to have their assets deposited outside the currency of origin.
To contrast this concept, during the start of the Cold War in the mid 1950s, all the money made by Russia from the sale of oil (which came in the form of US Dollars) was deposited in banks that were outside of the US for fear that the US Government would freeze the funds. This helped bring about a large amount of dollars that were not in the control of the US authorities.
The US government tired to impose laws restricting the loaning of dollars internationally. The Euro markets were particularly attractive because they had far fewer regulations and offered a much higher yield. Towards the end of the 1980’s, US companies began borrowing offshore and this is the norm today. Investors and savers find the Euro markets a lucrative and safe area to put their excess liquidity. In turn, these deposits provide short-term loans and finances import and export activities.
London was the principal offshore market, as it remains even now. In the 1980s, it became the key center in the Eurodollar market when British banks began lending dollars as an alternative to pounds. This allowed them to maintain their leading position in global finance. London’s convenient geographical location allows it to operate during Asian, Pacific and American market hours as well.
As Forex trading has grown, several international cities have emerged as market leaders. Currently, London, England has the greatest share of transactions with over 32% of the total trade volume. Other leading trading centers listed in order of volume are New York, Tokyo, Zurich, Frankfurt, Hong Kong, Paris, and Sydney.
Currently, the Forex market has expanded from consisting of only banks to one where many other kinds of institutions participate. The evolution of the Forex - from a range of loosely connected national financial centers to a single integrated international market – brought about a system that offers means of trading to not only financial professionals but also individuals who began trading and investing, and one that also plays an important role in our economies - both individual and national.
Since the late 1970s the Forex has seen an influx of financial entities, such as banks, hedge funds, and broker trading houses, as well as individual traders enter the Forex arena. Today, instead of being controlled by national banks and governments, the main factor that drives today's Forex markets is supply and demand. The free-floating system is ideal for today's Forex markets as international trade and commerce are abundant in the 21st century. The tremendous growth and application of technology in the Forex market broke down all barriers between nations, as well as time zone barriers eventually resulting in a 24 hour market throughout the American, European, and Asian time zones. Through the popularization of the internet, the trading of Forex online has enabled the average investor to reach this vital and practical market.