Forex Exchange

This article will follow the historical roots of the international currency trading from the days of the gold exchange, through the Bretton Woods Agreement, to its current setting.

The Gold exchange period and the Bretton Woods Agreement.

Prior to Bretton Woods, the gold exchange standard -- paramount between 1876 and World War I -- ruled over the international economic system. Under the gold exchange, currencies experienced a new era of stability because they were supported by the price of gold.

However, the gold exchange standard had a weakness of boom-bust patterns. As a country's economy strengthened, its imports would increase until the country ran down its gold reserves, which were required to support its currency. As a result, the money supply would diminish, interest rates escalate and economic activity slowed to the point of recession. Ultimately, prices of commodities would hit bottom, appearing attractive to other nations, who would rush in and amid a buying frenzy inject the economy with gold until it increased its money supply, driving down interest rates and restoring wealth into the economy. Such boom-bust patterns abounded throughout the gold standard until World War I temporarily discontinued trade flows and the free movement of gold.

The Bretton Woods Agreement, established in 1944, fixed national currencies against the dollar, and set the dollar at a rate of USD 35 per ounce of gold. The agreement was aimed at establishing international monetary steadiness by preventing money from taking flight across countries, and to curb speculation in the international currency market. Participating countries agreed to try to maintain the value of their currency within a narrow margin against the dollar and an equivalent rate of gold as needed. As a result, the dollar gained a premium position as a reference currency, reflecting the shift in global economic dominance from Europe to the USA. Countries were prohibited from devaluing their currency to benefit their foreign trade and were only allowed to devalue their currency by less than 10%. The great volume of international Forex trade led to massive movements of capital, which were generated by post-war construction during the 1950s, and this movement destabilized the foreign exchange rates established in Bretton Woods.

The year 1971 heralded the abandonment of the Bretton Woods in that the US dollar would no longer be exchangeable into gold. By 1973, the forces of supply and demand controlled major industrialized nations' currencies, which now floated more freely across nations. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, and new financial instruments, market deregulation and trade liberalization emerged.

The onset of computers and technology in the 1980s accelerated the pace of extending the market continuum for cross-border capital movements through Asian, European and American time zones. Transactions in foreign exchange increased intensively from nearly billion a day in the 1980s, to more than $1.9 trillion a day two decades later.