The origins of the Forex Market can be traced back to centuries ago. Since then, the Forex Market has come forward by leaps and bounds. This is the story of how it all began, from the birth of the Forex Market to the present day when it has established itself as the largest economic market in the world.
To learn about the history of the Forex Market, you first need to know about the history of trading practices. The earliest records of trading, as we know today, can be traced back to the middle ages when all the townsfolk crowded in areas known as the markets and exchanged goods and services. During the early days, there was no concept of money and neither was trading practiced with a mindset to make profits. People needed to exchange goods and services for the purpose of survival.
Currency, as we know now, was only invented as late as 5000 B.C. Before that, people traded their own possessions for the goods and services that they required. This was called the barter system. For instance, one could exchange two goats and a cow for 20 bags of rice. Besides animals, precious stones and exotic feathers were also exchanged for essential commodities.
However, the barter system suffered from some obvious drawbacks. People eventually started to feel the need for a common currency base value. The peculiar feathers and animal parts were soon started to be replaced by precious metals like gold and silver.
The Golden Times
The advent of gold as a currency for exchange was a milestone in the history of the Forex Market. Metals such as gold, silver, and copper started to be minted as coins and used as a currency for trade.
People could now use these currencies to buy the essential goods and services that they needed instead of using the outdated barter system. This memorable event in history is often regarded as the birthing point of the Foreign Exchange Market.
After this point of time, trading seized to be practiced just for the sake of survival. People engaged in the trade of goods and services with the hopes of making profits from it. The infrastructure was developed with the setup of ports to allow transactions of massive goods on a global scale.
With the barter system out of the way, traders could now import and export their products even to international markets where gold was accepted as the common currency base.
With time, different countries started minting their own currencies to help with the trade. One could always convert the currencies to gold if they wished. The traders and buyers rarely converted paper currency to gold even though the option was available. However, this led to another problem. The abundance of the paper money led to a hyperinflation that started threatening the world economy. Immediate measures needed to be taken to bring the inflation under control and once and for all, stabilize the political situation and the world economy.
The Bretton Woods Agreement: A Solution
The economic and political instability reached new heights during the last phases of the World War II, with the whole world succumbing to the resulting chaos. There was an urgent need to correct the situation and bring everything back to order.
The solution to the problem came in the form of the Bretton Woods Agreement, an initiative that was taken in July of 1944. This marked a landmark in the historical journey of the Foreign Exchange Market.
The Bretton Wood Agreement gave birth to the famous Bretton Wood Twins, The World Bank and the International Monetary Fund along with GATT.
One of the initial tasks of the Bretton Woods Agreement was to peg the values of all the different currencies to the valuation of gold. Gold was in turn valued in terms of the US Dollar. This remarkable decision was made to put a stopper on the global economic instability and the fluctuations in the exchange rates between the various currencies of different countries.
This also put an end to the various selfish manipulative techniques that were adopted by the governments of different countries to help them gain profits from the trading markets.
Although the Bretton Woods Agreement was chalked up as a permanent solution to all global economic problems, cracks soon began to show in the system. The Bretton Woods Agreement had pegged the valuation of all currencies to gold. However, the limited supply of gold could not keep up with the steady demand for the US Dollar, an outcome that could not have been predicted by the Agreement.
The limited reserves of gold were just not enough to keep up with the steadily increasing demand for USD that were needed to establish a harmony in the world trade and promote economic growth.
Instead of advancing the world economy even further which was the original goal of the agreement, it started slowing down the pace of economic development. Immediate actions needed to be taken to salvage the world economy from collapsing on itself.
Floating Exchange Rates: A New Strategy
Even though it lasted for a short time, the Bretton Woods Agreement provided novel solutions to the economic problems that existed during those times. The changes adopted by the agreement lasted only for a short while. The constant demand for USD made it impossible for the system to go along any further.
On 25th August of 1971, President Nixon of the United States made the shocking announcement of ending the accord, essentially dissolving the Bretton Woods Agreement. This opened the market to a free-floating currency system where the currency rates would fluctuate depending on the demand and supply.
Even then, a number of countries strived to bring back the fixed rates of currency, however, all attempts were futile.
In place of the fixed exchange rates that predominated the earlier days, the new free-floating currency system was determined by the Forex Market and was influenced by the demand and supply of the currencies in relation to other currencies.
This meant even the micro-level trading activities of a “stay-at-home Forex Trader” could essentially have an impact of the macro-level Forex market and the valuation of the currencies.
The traders could profit by entering the Forex trade at the right time, likewise lose out on valuable savings by entering it at a wrong time.
The Present: Electronics Communication Network
Initially, it was just the big fishes in the ocean like the banks, large companies and hedge funds who took part in the Foreign Exchange Market. It was essentially the ones with the bigger pockets who traded in the free-floating currency market.
However, the scenario soon began to change with the revolutions in the technological arena. With the advent of the internet and the World Wide Web, virtually anyone located on any part of the planet could now take partake in the Forex market.
A major landmark was the introduction of the Electronic Communications Network (ECN) in 1990 in the United States that shoved the Forex Trade Market to its worldwide glory. A new terminology was added to the dictionary – “electronic trading” that essentially captured the global impact that the Forex market could now enjoy.
The foreign currency exchange process was no longer concentrated in the hands of large banks or hedge funds. Rather, the decentralized nature of the ECN made it viable for investors from all around the globe to dabble in the Forex Market regardless of their economic standing or nationality.
The Forex Market saw the appearance of new players – The Forex brokers. The brokers essentially became key role players, establishing themselves as channels in the system via whom the BID and ASK prices were set. The difference between the Bid and the Ask prices, also known as the Spread is the prime source of income for the brokers.
It is the brokers who trade in the ECN network on behalf of their customers, thus making a profit on the commission. The brokers make this commission by selling the currencies at a price higher than price they bought it for. The rates of currencies differ from one broker to another.
Trading in the Forex market has become exponentially easier with the introduction of the ECN network. Retail Forex Traders like you and me can now easily get in touch with a broker, download the needed software and start placing their bids in absolutely no time. Gone are the days when you would have to have the sizeable bank balance to take part in the Forex Trade. The deposits starting at low prices, virtually anyone can now become a Forex Trader. The trades can start with amounts as low as a hundred dollars.
The economy in general and the trading market, in particular, have taken a gigantic leap forward from the crude processes of the barter system in the historic times.
Now that we have covered our bases about the beginning of the Forex Market, let me take you through a trip to how the Forex Market actually works and who trades in the Forex Market in the next chapter.