History of the Forex Market

Forex, or foreign exchange, trading (swapping one currency for another) has a rich history. Many world currencies were previously set on a gold standard – individuals could trade in paper currency issued by the government for its value in gold. Even earlier than that, many nations simply created coins directly from the metal (such as gold or silver) their currency was based on. Simply put, that currency had a set value backed by the physical metals.

Governments later moved away from full gold backing – because the bulk of paper currency wasn’t being traded in for gold, they essentially decided they could back more money with less gold on-hand. This meant that countries would produce and release more paper money into their economies, which led to more fluctuation in the markets, and inflation.

The Bretton Woods Agreement

Towards the end of WWII, officials from many nations met in the United States with the goal of creating stability in world currency markets. Previously, many governments used the British Pound Sterling (GBP) as their primary point of comparison. When the Bretton Woods Agreement (or Bretton Woods Accord) was reached, that changed (due to devastation in Britain during the war).

Instead, the value of global currencies was then compared to the U.S. Dollar (USD). The dollar, in turn, was based on a set value backed by gold – USD $35 per ounce of gold.

This system lasted until 1971. While it ultimately failed, it did play a role in stabilising the Japanese and European economies as hoped. There were several reasons the Bretton Wood Agreement didn’t survive. For example, the value of the USD was affected by trade and budget deficits at the time, and the narrow fluctuations allowed under the system couldn’t be supported by a resource as limited as gold anymore. Economies were growing and shrinking in drastically different ways across the globe, and the foreign exchange market / currency values had to account for that.

The Free Floating System

Other attempts have been made to standardize currency values. One example of this is the decrease or elimination of several European currencies in favour of the Euro.

Despite these attempts, the Forex market eventually worked its way into a relatively free floating system, which spurred it to becoming the largest trading market in the world. In a free floating system, currency values (in comparison to other currencies) can fluctuate greatly. Like in the stock markets, Forex trading is now based primarily on supply and demand, with minimal government intervention compared to their currency regulation attempts under the Bretton Woods Accord and similar agreements.