Lesson 2 – Forex History

When the second World War was close to its end, the United States initiated an agreement in July 1944, at The Bretton Woods in New Hampshire. The agreement suggested that the new reserve currency of the world should be built on the US Dollar system, contrary to what John Maynard Keynes was suggesting, the introduction of a new currency for the world reserve.

The World Bank, IMF, GATT and other international institutions were also created around that time by the Second World War victors who wanted to avoid another monetary crises like the one which lead to the war. Following the Bretton Woods agreement, the Gold standard was partly reinstated and there was a fixed exchange rates system built. The rate for the U.S. Dollar was $35.00/ounce of Gold. The other currencies were fixed depending on the dollar.

What was intended through this agreement was the steadiness of the international monetary system by keeping money inside countries and to prevent speculation on the international market of currency. The countries which took part in this agreement engaged themselves into trying to keep their currencies value within a small interval of variation relative to the dollar and the equivalent gold rate as required by needs.

This lead to the dollar becoming an important reference currency. All the shifts in the economic dominance in the world between USA and Europe were reflected through the Dollar value. Countries were not allowed to put advantage to their foreign trade by devaluing their currency, unless it was by 10% the most. The international Forex trade volume proved to be of great dimensions, so the capital movements were also massive. This was mainly due to the post-war construction taking place in the 1950s. This had as result the destabilization of the foreign rates for exchange which were set in the Bretton Woods agreement.

In 1971 the agreement in Bretton Woods was abandoned and the US dollar seized to be exchangeable to Gold.

In 1073 the currencies of the major industrialized nations were controlled bz the demand and supply system. From that point on prices floated daily. The 1970s represented a great increase in price and speed volatility, as well as volumes, so trade liberalization emerged along with market deregulation and other financial instruments.

Free Floating system

In December 1971 there was another Agreement signed, the  Smithsonian Agreement. It took over most of the Bretton Woods settlements, but established a greater currency fluctuation band.  The European community tried, in 1972 to take distance from depending on the dollar. Therefore, there was established the European Joint Float by 6 countries: Luxemburg, Belgium, The Netherlands, Italy, France and West Germany.

None of these two agreements managed to set a perfect system and made, more or less, the same mistakes as the accord from Bretton Woods. Therefore, they collapsed in 1973. Consequently, countries involved officially switched to the system of free floating, which was officially mandated in 1978.

In July 1978 European countries created the European Monetary System, in their attempt to free themselves from the dollar dependency. However, this system also failed, but much later, in 1993.

Presently, major currencies have the freedom of moving without depending on other currencies. Anyone who wishes can trade currencies. This is why speculation increased due to the activity of brokerage houses, hedge funds, banks and individuals. Sometimes central banks may intervene to influence currencies to reach the levels they desire by moving or just attempting to move those currencies. However, supply and demand remains the main factor driving the forex markets nowadays.

The market expended even more in the 1980s due to the development of technology and the wide use of computers. This allowed for capital to move across borders, through American, Asian and European time zones. In the 1980s transactions in foreign currencies were at a level of almost billion a day. Two decades later they reached a level of over 1.9 trillion dollars.

The Euro

In 1979 there was a new fixed exchange rates system introduced by the European Economic Community. This was the new European Monetary System. However, this system almost disappeared in 1992 to 1993. Some weak European currencies were forced towards devaluation. The Maastricht treaty from 1991 tried to establish a new currency stability.