HISTORY OF FOREXT
he Foreign Exchange may be traced back to the early stages of history, possibly beginning with the Ancient Egyptians' introduction of coinage, and the Babylonians' notes. Certainly by biblical times the Middle East saw a form of rudimentary international monetary system when the Roman gold coin 'aureus' gained 'world wide' acceptance followed by the silver 'denarius,' both a common stock among money changers of the period. By the Middle Ages, foreign exchange became a function of international banking with the growth in the use of bills of exchange by the merchant princesses and international debt papers in the course of their underwriting the period's wars by the budding European powers.
The Gold Standard, 1816-1933
The 'gold standard' was a fixed commodity standard where participating countries fixed a physical weight of gold for the currency in circulation making this directly redeemable in the form of the precious metal. In 1816 for instance, the pound sterling was defined as 123.27 grains of gold on its way to becoming the foremost reserve currency and was the principal component of the international capital market. This led to the expression 'as good as gold' when applied to the Sterling, as the Bank of England at the time gained stability and prestige as the premier monetary authority.
Of the 'majors,' the US dollar adopted the gold standard late in 1879 and became the standard-bearer replacing the British Pound when Britain and the other European countries came off the system with the outbreak of World War I in 1914. Eventually, though, the worsening international depression lead even the dollar off the gold standard by 1933 marking the period of collapse in international trade and financial flows prior to World War II.
The Bretton Woods System, 1944-73
The post World War II period saw the British economy in ruins with infrastructure bombed, so too was confidence with their currency at a low. On the other hand, the US with its physical isolation was left relatively unscathed by war, its industrial might ready to be turned to civilian purposes. This then has lead to the dollars rise to prominence becoming the reserve currency of choice and staple to the international financial markets.
Bretton Woods came about in July 1944 when 45 countries attended at the behest of the US a conference to formulate a new international financial framework, aimed at ensuring prosperity in the post war period and to prevent the recurrence of the 1930s global depression. Named after a resort hotel in New Hampshire, the Bretton Woods system formalized the role of the US dollar as the new 'global' reserve currency with its value fixed into gold and the US assuming the responsibility of ensuring convertibility while other currencies were pegged to the dollar.
Among the key features of the new framework were :
i) fixed but adjustable exchange rates.
The End of Bretton Woods and Floating Exchange Rates
ii) the International Monetary Fund
iii) the World Bank
After close to three decades of running the international financial system, Bretton Woods finally went the way of history on growing structural imbalances among the economies leading to mounting volatility and speculation in a one-year period, from June 1972 to June 1973. At the time the UK, facing deficit problems initially floated the Sterling, then devaluating further on in February of 1973 loosing 11 per cent of its value along with the Swiss Franc and the Japanese Yen. This eventually lead to the European Economic Community floating their own currencies as well in the end.
At the core of Bretton Woods problems were deteriorating confidence in the dollars ability to maintain full convertibility and the unwillingness of surplus countries to revalue for its adverse impact in external trade. Despite a last ditch effort by the Group of Ten finance ministers through the Smithsonian Agreement in December 1971, from 1973 onwards the international financial system saw market-driven floating exchange rates taking hold. Several times efforts for reestablishing controlled systems were undertaken with varying levels of success, the most well known of which Europe's Exchange Rate Mechanism of the 1990's that eventually lead to monetary union and today's 12 nation Euro.