We've learned a lot thus far and it's almost time to start trading, but given the global nature of the forex exchange market, it's important to first examine and learn some of the important historical events relating to currencies and currency exchange. In this section we'll take a look at the international monetary system and how it has evolved to its current state. Then we'll take a look at the major players that occupy the forex market - something that is important for all potential forex traders to understand.

History of Forex: the Gold Standard System

The creation of the gold standard monetary system in 1875 is one of the most important events in the history of the forex market. Before the gold standard was created, countries would commonly use gold and silver as method of international payment. The main issue with using gold and silver for payment is that the value of these metals is greatly affected by global supply and demand. For example, the discovery of a new gold mine would drive gold prices down given the sharp increase in gold supply. (For background reading, see The Gold Standard Revisited.)

The basic idea behind the gold standard was that governments guaranteed the conversion of currency into a specific amount of gold, and vice versa. In other words, a currency was backed by gold. Obviously, governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges. During the late nineteenth century, all of the major economic countries had pegged an amount of currency to an ounce of gold. Over time, the difference in price of an ounce of gold between two currencies became the exchange rate for those two currencies. This represented the first official means of currency exchange in history.

The gold standard eventually broke down during the beginning of World War I. Due to the political tension with Germany, the major European powers felt a need to complete large military projects, so they began printing more money to help pay for these projects. The financial burden of these projects was so substantial that there was not enough gold at the time to exchange for all the extra currency that the governments were printing.

Although the gold standard would make a small comeback during the years between the wars, most countries had dropped it again by the onset of World War II. However, gold never stopped being the ultimate form of monetary value and is generally regarded as a safe haven for those seeking stability. (For more on this, read What Is Wrong With Gold? and Using Technical Analysis In The Gold Markets.)

Bretton Woods System

Before the end of World War II, the Allied nations felt the need to set up a monetary system in order to fill the void that was left when the gold standard system was abandoned. In July 1944, more than 700 representatives from the Allies met in Bretton Woods, New Hampshire, to deliberate over what would be called the Bretton Woods system of international monetary management.

To simplify, Bretton Woods led to the formation of the following:

  • A method of fixed exchange rates;
  • The U.S. dollar replacing the gold standard to become a primary reserve currency; and
  • The creation of three international agencies to oversee economic activity: the International Monetary Fund (IMF), International Bank for Reconstruction and Development, and the General Agreement on Tariffs and Trade (GATT).

The main feature of Bretton Woods was that the U.S. dollar replaced gold as the main standard of convertibility for the world's currencies. Furthermore, the U.S. dollar became the only currency in the world that would be backed by gold. (This turned out to be the primary reason why Bretton Woods eventually failed.)

Over the next 25 or so years, the system ran into a number of problems. By the early 1970s, U.S. gold reserves were so low that the U.S. Treasury did not have enough gold to cover all the U.S. dollars that foreign central banks had in reserve.

Finally, on August 15, 1971, U.S. President Richard Nixon closed the gold window, essentially refusing to exchange U.S. dollars for gold. This event marked the end of Bretton Woods.

Even though Bretton Woods didn't last, it left an important legacy that still has a significant effect today. This legacy exists in the form of the three international agencies created in the 1940s: the International Monetary Fund, the International Bank for Reconstruction and Development (now part of the World Bank) and the General Agreement on Tariffs and Trade (GATT), which led to the World Trade Organization. (To learn more about Bretton Wood, read What Is The International Monetary Fund? and Floating And Fixed Exchange Rates.)

History Of Exchange Rates

Related Articles
  1. Investing

    Does it Still Pay to Invest in Gold?

    Gold's appeal dates back thousands of years. Find out whether gold can live up to the hype.
  2. Trading

    Forex: World's Biggest Market A Relative Newcomer

    Unlike the stock markets, the forex market is a truly new market. We’ll take a brief look at its origins and how it works today.
  3. Investing

    How gold affects currencies

    There is a strong correlation between gold's value and the strength of currencies trading on foreign exchanges.
  4. Investing

    The Midas Touch For Gold Investors

    Find some golden opportunities by investing in gold commodities or futures contracts.
  5. Investing

    Why Gold Matters

    Gold is a very useful investment during periods of instability and high inflation.
  6. Investing

    8 Reasons To Own Gold

    This precious metal's rich history stems from its ability to maintain value over the long term.
  7. Investing

    What Is Wrong With Gold?

    Despite its historic and symbolic appeal, this metal is simply a commodity. Here we explore its meaning as an investment.
  8. Financial Advisor

    4 Ways You Can Invest In Gold Without Holding It

    Owning gold can be a store of value and a hedge against unexpected inflation. Holding physical gold, however, can be cumbersome and costly. Fortunately, there are several ways to own gold without ...
  9. Investing

    Is Now the Right Time to Buy Gold Mining Stocks?

    Examine the current case for buying gold stocks, and learn the reasons why gold and mining stocks may be set to begin a new rally in the near future.
Frequently Asked Questions
  1. How do interest rate changes affect the profitability of the banking sector?

    Learn how interest rates affect the banking sector. When interest rates rise, the profitability of the banking sector increases.
  2. Is there a difference between capital gains and dividend income?

    Selling something for a profit leads to capital gains. A payment made by a corporations to stockholders is a dividend. Both ...
  3. What is an Islamic investment policy?

    Islamic investments are a unique form of socially responsible investments because Islam makes no division between the spiritual ...
  4. What Is The Prime Cost Formula?

    Prime costs are the costs directly attributed to the production of a product. Before calculating prime costs, direct costs ...
Trading Center