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History of Foreign Currency Exchange Market

History Of Foreign Currency Exchange Market

The roots of trading of currencies can be traced back to the Middle Ages. It was developed by the development of bills of exchange by international merchant bankers. These bills of exchange represented transferable third-party payments, which facilitated both flexibility and growth in the trades that included foreign exchange.

The forex as we know it today with its volatility and relative stability began to be shaped in the 20th century.

At that time London was a leading foreign exchange center. As a result the British pound turned into the major currency for executing trades. Additionally, it was the main currency in which bank reserves were held.

The use of telex machines or cable for the execution of currency trades during those times gave the pound the nickname cable. However, the World War II left Britain economically devastated.

This led to the emergence of the USA as a financial center, since its economy was not greatly influenced by the negative impacts of the war.

Combined with the Breton Woods Agreement of 1944 between the USA, Great Britain and France, the US dollar was turned into the reserve currency for the capitalist countries. As a result all other currencies were linked to the American dollar.

The currency rates were allowed to be adjusted by the central banks of the corresponding country by using such means as interventions or the purchase of currencies. On the other hand the gold was used as a base measure for the value of the US dollar, meaning that it was linked to it. As a result, the US dollar was turned into the reserve currency of the world economy.

The International Monetary Fund (IMF) was established under the same agreement. Its major activities surrounded the financial support of the former socialist countries and the developing countries that were undergoing a transformation of their economic activities after the war. In order to achieve its goals the IMF applied the following activities:

  • monitoring of economic and financial developments, as well as providing policy advice with the purpose of crisis-prevention;
  • IMF lending to countries having difficulties in balance of payments;
  • technical assistance and training in order to help member countries to effectively manage their financial and economic activity.

The main factor that contributed to the development of the foreign exchange market as we know it today is the free-floating of currencies that was established at the end of the seventies.

The free-floating of currencies represents the ability of everyone to be involved in the trading of currencies, while their prices are determined by the levels of supply and demand.

Additionally, this principle includes the aspect of no particular intervention point occurrence. As a result of the free-floating of currencies, the volume growth has significantly increased.

The major factors that contributed to the increase in the volume of currencies trade include:

  • Volatility of currencies rates.
  • The experienced technology revolution in currency trading, facilitated by the introduction of automated dealing systems and the development of the Internet.This factor contributed to a particularly great extent to the development of the forex market. The connection of traders located all around the world was made possible by dealing machines. Traders have become more sophisticated due to the advances in technology, computer software and telecommunications. As a result their ability to make profits and deal appropriately with the risks of foreign currency trading has increased.
  • Mergers of corporations of different origin.
  • Increasing two-way influence of different economies over bank-rates set by central banks.
  • Goods markets experienced higher competition.