Foreign exchange trading can trace its history back to the Middle Ages when international merchant bankers first devised the system of using third-party transferable payments in the shape of bills of exchange. However, the real growth of the Forex market took place as a result of events during the twentieth century.
Although currency trading has a long history dating back to the middle ages, it is the changes that we have seen during the twentieth century which have created the Forex market we see today.
During the first half of the twentieth century the British pound was the world's principal trading currency and was the currency held by many as their main 'reserve' currency. As a result, London was also seen as the leading center for foreign exchange. However, the Second World War severely damaged the British economy and so the United States dollar took over as the world's principle trading and reserve currency and retains that position today. This said, there are now a number of other currencies, principally the Yen and the Euro, which are also seen as reserve currencies.
Since the Second World War there have been a number of events which have proved instrumental in shaping today's Forex market.
The first was the signing of the Bretton Woods Accord in 1944 which stipulated that the United States, Britain and France would stabilize the world currency markets by pegging the major world trading currencies to the US dollar (which was itself pegged to the price of gold). This in effect meant that if the price of a currency against the US dollar fluctuated by more than one percent the central bank concerned had to intervene and buy or sell the currency in question as necessary to bring it back to within its one percent bracket.
The Bretton Woods Accord also set in motion the establishment of the International Monetary Fund (IMF) which was designed to provide a stable system for buying and selling currencies and to ensure that currency transactions could take place smoothly and in a timely fashion.
In addition, the aim of the IMF was to create a consultative forum to promote international co-operation and to facilitate the growth of world trade, while at the same time breaking down exchange restrictions which hindered international trade.
It was also part of the established role of the IMF to make financial resources available to member states on a temporary basis where this was considered necessary to further the aims of the IMF. Such loans were normally only made on the understanding that the country concerned would make substantial changes to rectify the situation which gave rise to the need for the loan in the first place.
One of the most significant events as far as the Forex market is concerned occurred in 1978 when the IMF proposed that currencies should become 'free-floating'. In other words, currencies should be traded against one another at a price that was dictated solely by the law of supply and demand and that there should no longer be a requirement to peg currencies to the dollar or for central banks to intervene in currency trading to support the price of a currency. This is not to say that central banks were prevented from intervening if they chose to do so, but merely that such intervention would now be entirely a matter of choice and not a requirement as previously stipulated by the Bretton Woods Accord.
The next major milestone was the establishment of European Monetary System which effectively came into force in 1979. The European Monetary System got off to something of a shaky start when Britain (one of the principle members of the European Community) decided not to join the system and Italy joined only under special arrangements. Britain did however later agree to participate to a limited degree by joining the exchange mechanism of the European Monetary System in 1990.
The final major development to affect the Forex market was the establishment of the Euro as a single currency for European Union member states in 1998 with eleven of the participating states replacing their national currency with the Euro.
Of all these developments it was the free-floating of currencies in 1978 which did more than anything else to boost the growth of the foreign exchange market. In 1978 Forex trading showed a daily turnover of about 5 billion US dollars and this figure rose in the following ten years to reach 600 billion US dollars by 1988. By 1992 this figure had reached 1 trillion US dollars and the figure continued to rise to a level of 1.5 trillion dollars by the turn of the century.
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