History of the Forex Market

Money, in one form or another, has been used by man for centuries. At first it was mainly gold or silver coins. Goods were traded versus other goods or against gold. So, the price of gold got a reference point. But as the trading of goods grew among nations, moving quantities of gold around places to settle payments of trade became cumbersome, risky and time consuming. Therefore, a system was sought by which the payment of trades could be resolved in the seller's local currency. But how much of buyer's local currency should be equal to the seller's local currency?

The answer was simple. The strength of a country's currency depended on the amount of gold reserves the country preserved. So, if country A's gold reserves are double the gold reserves of country B, country A's currency will be twice in value when exchanged with the currency of country B. During the first World War, in order to meet the tremendous financing needs, paper money was created in quantities that far exceeded the gold reserves.

After the cease of World War II the western allied powers tried to resolve the problem at the Bretton Woods Conference in New Hampshire in 1944. In the first three weeks of July 1944, delegates from 45 nations gathered at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire. The delegates gathered to discuss the postwar recovery of Europe as well as a number of monetary issues, such as unstable exchange rates and protectionist trade policies. In the early 1940s, the United States and Great Britain developed proposals for the creation of new international financial institutions that would stabilize exchange rates and promote international trade.

The delegates at Bretton Woods arrived at an agreement known as the Bretton Woods Agreement to establish a postwar international monetary system of convertible currencies, fixed exchange rates and free trade. To help these objectives, the agreement created two international institutions: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (the World Bank). The aim was to render economic aid for reconstruction of postwar Europe. An initial loan of $250 million to France in 1947 was the World Bank's first act.

Under the Bretton Woods Exchange System, the currencies of active nations could be changed into the US dollar at a fixed rate, and foreign central banks could change the US dollar into gold at a fixed rate. It was similar to forex trading.

The United States, under President Nixon, retaliated in 1971 by devaluing the dollar and pushing realignment of currencies with the dollar. The heading European economies tried to counter the US move by adjusting their currencies in narrow band and then float jointly against the US dollar.

Fortunately, this currency war did not last long and by the first half of the 1970's heading world economies gave up the fixed exchange rate system for good and floated their currencies in the exposed market. The idea was to let the market determine the value of a given currency based on the demand and supply of the currency and the economic wellness of the currency's nation, it sown the forex trading. This market is popularly known as the International Monetary Market or IMM. This IMM is not a single entity. It is the collection of all financial institutions that have any concern in foreign currencies, all over the world. Banks, Brokerages, Fund Managers, Government Central Banks and sometimes individuals, are just a few examples.

Although the currency's value is dependent on the market forces, the central banks still try to keep their currency in a predefined (and highly confidential) fluctuation band as a part of their forex trading strategies. They achieve this by taking several steps.