The forex market is the largest financial market in the world. It has a rich history, and many important global events have shaped modern foreign exchange trading. Here is a chronicle of the history of the worldwide forex markets and the key events that have led to its evolution.
The Foreign Exchange (Forex) Market is the largest financial market globally. Forex trading is centuries old and dates back to the Mesopotamian period. The modern foreign exchange market has been shaped by several global events, like the Bretton Woods and the gold standard.
Today the forex market comprises 170 different currencies. The total value of the forex industry stands at $2.409 quadrillion in 201944. The daily turnover of currency trading has increased to $6.6 trillion as of 2019, from $5.1 trillion in 2016.
This article chronicles the deep history of the forex market right from the days of the barter system to today’s online trading platform and every significant event that has happened in between.
The Mesopotamia tribes introduced the oldest method of exchange, the barter system, in 6000 BC1. The barter system involved the exchange of goods via ships. As the system evolved, salt and spices emerged as the most popular methods of exchange.
Introduced by Mesopotamia tribes, bartering was adopted by Phoenicians. Phoenicians bartered goods to those located in various other cities across oceans. Babylonians also improvised their existing bartering system wherein goods were exchanged for food, tea, weapons, and spices. The barter system saw a significant change with the widespread adoption of gold coins in the 6th century BC2.
Gold Coin became a mode of exchange because of its durability, divisibility, acceptability, and uniformity. The wide popularity of metal as a medium of exchange formed the foundation of coinage. Ancient Egypt used gold bars of predetermined weight from the 4th millennium BC and finally developed gold rings as currency3. However, coinage was not part of foreign trade until the late 4th century AD.
Gold rings served dual purposes for a long time as an accessory and currency. Gold and silver bars which could be cut into segments also supplemented gold coins. The availability of metal determined the material that would be used. Coins or bars became a challenging mode of exchange in international trade because there was no standardized method to ascertain their value.
This authentication problem could be solved by using coins produced by a single, trusted issuer. The first coin to be widely accepted for international trade was the Aegina “turtle” coin, a silver coin minted on the island of Aegina.
Situated between Greece and Turkey, the Aegean Sea used heavy copper ingots as currency many centuries before the invention of true coinage. These ingots, also known as talents, were a unit of weight that measured nearly 55 to 60 pounds4.
During the Middle Ages, 1000 years ago, copper emerged as the most commonly used metal for coin minting and trading due to its low value5. Today, the US 1-cent coins are made out of 2.4% copper and 97.6% zinc6.
The Greeks primarily used bronze, copper alloyed with tin, or simply copper for the token coinages. On the other hand, the Romans used an alloy of copper and zinc, a type of yellowish brass called orichalcum, for the higher token denominations and redder copper for the two smallest denominations7.
Greeks and Romans also added lead or used lead bronze to their coins because it made the coins softer and easier to strike3. At the same time, Italy used bronze to form a currency in early times before moving on to iron bars of regular weight.
True coinage began only after 650 BC. It was in the Roman Empire that currency minting was centralized8. It was also the first time that the government’s monopoly on currency trading was formalized. This is the same structure that exists even today wherein Central banks across the globe take a final call on the monetary policies.
By the 4th century AD, the currency market was primarily controlled by the Byzantine Empire, owing to its importance in global trade. When the Roman Empire declined in the 5th century, ‘bezant,” or the equivalent of the gold _solidu_s which the Byzantium empire issued in Western Europe, became a means for international trade currency.9
In the 13th century, the Republic of Florence emerged as a new Mediterranean power. From 1252 to 1533, Florence minted a gold coin known as the “fiorino d’oro” or “florin.” The Florin had a fixed gold content of 72 grains, and it became the standard currency for international trade in Europe in a short time. At the same time, the silver coin minted by Florence was known as ‘fiorino d’argento’10
Other major cities across Europe followed the footsteps of Florence and minted their gold coins. However, the quantities of gold in these coins varied. Thus, the Florentine coin was used as a benchmark to measure the international value of the other. We can consider this as a primitive form of the gold standard that followed later.10
In 1532, the Medici family became the duke of Florence. The Italian Medici family opened banks to facilitate the exchange of currencies on behalf of indigenous textile traders. They also kept track of the exchange between local and international currencies in a book which they called a Nostro.10
Monte dei Paschi, the world’s oldest bank, located in Tuscany City in Italy, originated in 1472. However, it standardized its operations in 1624, and its sole objective was to facilitate currency transactions.11
618 AD – The Launch of Paper Note and The First Forex Markets
The paper currency was invented in China under the Tang Dynasty (618AD – 907AD), though it was used widely during the Song Dynasty (AD 960–1279) as promissory notes called “Jiaozi.”12. Merchants and wholesalers mostly used it as proof of credit that they granted to the buyer. It was not convenient for merchants to carry large amounts of coins because of their weight and theft risk. Hence, they had to think about an alternative route. Paper notes became very popular during the 11th century.
During one of his visits to Asia, the Venetian explorer Marco Polo came across the concept of the banknote and introduced it to Europe through a chapter of his book, Travels titled “How the Great Khan Causes the Bark of Trees, Made into Something Like Paper, to Pass for Money All Over His Country.”13
Yet, the first banknote ever printed in Europe came out a few centuries after, in 1661 in Sweden. Stockholms Banco, Sweden’s first bank, issued the first genuine banknotes in Europe. Johan Palmstruch, the founder of Stockholms Banco, issued the banknotes as deposit certificates called kreditivsedlar. These notes were issued as an alternative to the massive copper coins in Sweden.1415
Paper notes became very common among European countries because they could be quickly produced at a lower cost than coins.
The first paper money was printed in the United States in 1690. On February 3, 1690, this money was issued by the Massachusetts Bay Colony worth 40,000 pounds. Paper money in the United States represented bills of credit or IOUs.The objective behind printing paper money was to assist with military funding during King William’s War against Canada.16
The development of currency usage and economic growth in Europe led to the launch of the first forex market in Amsterdam in the 17th century12. Amsterdam exchanged currencies between the County of Holland and England. The rates were set according to the imports and exports of currencies to the County of Holland.
Between 1820 and 1860, firms such as Alexander Brown & Sons in the U.S. became leading currency traders. Gradually, new participants began to participate in foreign exchange trading by the 1880s.47
However, foreign exchanges were officially established in the US only after 1880. Even the Gold Standard was first used in the 1880s.
The first coinage act of the United States was approved on April 2, 1792.17 It is the same year in which the United States mint was also established to oversee all mint operations and its employees such as Chief coiner, engraver, and assayer. The first minted coins in the United States were of gold, silver, or copper.
The official price of gold that the U.S. government ascertained remained constant at $19.39 per troy ounce between 1792 and 1834. After that, it was raised to $20.69 in 1834. In 1934, the price of gold was $35. In 1972, the price of gold went up to $42.22.
Under the presidency of Andrew Jackson, Congress passed the Coinage Act of 1834 to establish a new regulation of gold valuation. According to the new regulation, the weight and value of gold would be commensurate with the marketplace and its corresponding value to silver. Under the new act, the ratio of gold to the dollar was revised to be $20.67 per ounce of gold. Also, the percentage of silver-to-gold was about 16:1.18
Also known as the “Crime of 1873” by the silver miners in the west, The Coinage Act of February 12, 1873, demonetized silver and brought an end to the silver boom that had made the western states’ economies stronger.19 Silver gave way to the Gold Standard, which went on to be adopted by the leading economies of the world later.
However, the transition wasn’t smooth. The market price of silver plunged after 1873 because of reduced usage in the United States. The panic of 1873 led to the free coinage of silver becoming a political debate in the United States. What followed was a phase of economic hardship between 1873 and 1878 that led to the demand for cheaper paper money.
Mid-1870 – Free Silver Movement
Democratic Leader Willian Jenning Bryans and others propagated the Free Silver movement in the mid-1870s.20 They did not see a reason for the United States to hold a gold reserve equivalent to the paper money in circulation. They campaigned to restore silver backing for the dollar at a value that would increase farmers’ prices for their crops. Farmers believed that the inflated price of their crops would let them pay off their debt effectively.
The Free Silver Movement gained immense momentum and laid the foundation for the passage of the Bland Allison Act in 1878.21 This act re-established the silver dollar as legal tender and required the U.S. Treasury to purchase between $2,000,000 and $4,000,000 worth of silver each month and convert it into dollars. The demand for restoring the silver coinage was so strong that Congress passed this act over the veto of President Rutherford B. Hayes.
To address the growing complaints of farmers’ and miners’ interests, the Sherman Silver Purchase Act was passed in 1890.22 It replaced the Bland Allison Act and saw an additional purchase of 4.5 million ounces of silver bullion in a month. The bill was named after Senator John Sherman, a Republican from Ohio and chairman of the Senate Finance Committee. After the Sherman Silver Act was implemented, the US Federal Government became the second-largest buyer of silver globally, after the British Crown in India, where the Indian rupee had a silver backing instead of gold.
However, the Sherman Purchase Act threatened the U.S. Treasury’s gold reserves and led to an increase of $156 million in the amount of paper money in circulation. In a nutshell, the Sherman Act did no good even to the silver miners and Western farmers as they remained dissatisfied with the government’s compromises. In 1893, President Grover Cleveland, a staunch supporter of the gold standard, repealed this act because the U.S Treasury’s gold reserves were being depleted as investors sold silver in exchange for gold.
Gold has been used as the preferred currency since times immemorial. The earliest use is known to date back to 600 B.C. in Lydia, or present-day Turkey.
In the past, many civilizations have used gold coins to trade for goods and services. However, it wasn’t feasible to use the gold coins because they were pretty bulky, and transportation was difficult. In the 1800s, countries began to adopt the gold standard. The gold standard ensured that the government would redeem any amount of paper money for its value in gold. This was a trend until World War I, after which European countries had to suspend the gold standard to print more money to pay for the war.
It was in 1875, 240 years ago, that the Gold Standard was officially introduced. A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. In other words, a country could only mint as much national currency as there was Gold held in reserves. The purpose behind Gold Currency was to guarantee the value of a currency.
The Gold Standard Act of 1900 established gold as the only metal for redeeming paper currency.23 The standard guaranteed that the government would redeem any amount of paper money for its value in gold. It also meant it wasn’t mandatory to do transactions with heavy gold bullion or coins.
Gold played a crucial role in the international monetary system. In 1717, Britain’s currency was made a de facto gold standard when Sir Isaac Newton, the Master of the Royal Mint, fixed the value of the country’s silver coins corresponding to the gold guinea. As that value proved to be too high, silver’s use was gradually phased out. In 1816, Britain also officially adopted gold as the basis for its currency. The government committed to trading an ounce of gold for 4.247 pounds sterling.
After Britain, the United States adopted the gold standard where an ounce of gold was equivalent to $20.67.26 Following this, the Western European countries and Russia adopted the Gold Standard in 1897.
The gold standard was primarily used in the 19th and early part of the 20th century. After the first World War, countries were required to print more money to finance their expenses, which led to the end of the Gold Standard. Thus, in the 20th century, most nations abandoned the gold standard as the basis of their monetary systems, although many continue to hold substantial gold reserves.
On December 23, 1913, Congress established the Federal Reserve for stabilizing gold and currency values in the US. The Federal Reserve Act aimed to establish economic stability by introducing a central bank to supervise monetary policy.25 The 1913 Federal Reserve Act was brought into law by President Woodrow Wilson wherein 12 Federal Reserve banks received rights to print money to ensure economic stability. As a lack of available currency caused the earlier banking panics, a crucial responsibility of the Central Bank is also to respond to the local currency needs as per the specific regions.
1922 – Between the Two World Wars
The second phase of the international monetary policy commenced in 1922 in Genoa. The winners of World War I got benefits for their national currencies.
Gold Standard was the new system according to which the significant currencies – of the US, France, and Britain could be converted to gold. National currencies became the global mediums of reserves and payments. This allowed the countries to overcome the limitations of the gold standard. At the same time, the international monetary system became dependent on the economic health of the mentioned countries. The exchange of currency for gold could be made directly. The regulation of exchange rates became the latest state of the world’s financial system and the foundation of international monetary policy. This system created conditions for currency wars and devaluations.
As the Great Depression hit, investors began trading in currencies and commodities. With the rise in gold prices, people exchange their dollars for gold. Things took a turn for the worst when banks started to fail. People lost trust in financial institutions and began to hoard gold.
When the Federal Reserve Bank of New York could not honor its commitment to convert the currency to gold any longer, President Franklin D. Roosevelt shut the banks. He declared March 6, 1933, a national banking holiday.27
When the banks resumed operations on March 13, people had turned in all their gold to the Federal Reserve. They could neither redeem their dollars for gold nor export it.
Finally, on January 30, 1934, the private ownership of gold was prohibited except under the Gold Reserve Act, except allowed by the license.28 The act allowed the government to repay its debts in dollars, not gold. The Gold Reserve Act of 1934 followed a series of attempts to manage the financial crisis, including the bank holiday, suspension of international gold payments, and expansion in gold purchases by the Treasury.
The government recalled all the gold held by private hands and then stopped the Treasury from redeeming dollars for gold. All gold coins were ordered to be withdrawn from circulation and converted into bars. The government then “authorized the president to establish the gold value of the dollar.
After the Act’s passage, the President, Franklin D. Roosevelt, raised the statutory price of gold from $20.67 per troy ounce to $35. This price increase encouraged gold miners across the world to expand their production. Overseas nationals also began to export their gold to the United States, leading to the devaluation of the U.S. dollar by increasing inflation.
The increase in gold reserves because of the price change led to the massive accumulation of gold in the Federal Reserve and U.S. Treasury. Most of this gold was stored in the United States Bullion Depository at Fort Knox, Kentucky, and a few other locations.
The 1930s left a bad experience in everyone’s mind, and the policymakers wanted to make amends. The aggressive policies adopted by governments to combat the Great Depression, such as discriminatory trading blocs, high tariffs, and currency devaluations, destabilized the global environment and worsened the economic situation.
The lessons that the U.S. policymakers learned from the period between the wars laid the foundation of their approach to the global economy post-world war ii. President Franklin D. Roosevelt and a few others, such as the Secretary of State Cordell Hull, were staunch supporters of the Wilsonian belief, promoting free trade as a tool for prosperity and peaceful relationships.29
1945 was a landmark year in the history of currency markets because it was in this year that the Bretton Woods agreement came into effect.30 The objective of this agreement was to create a stable international financial mechanism anchored by gold.
The Bretton Woods Conference was officially called the United Nations Monetary and Financial Conference. A congregation of delegates from 44 countries that came together from July 1 to July 22 in Bretton Woods, New Hampshire, decided upon a new framework for the postwar international monetary system.
Although the conference acknowledged that the exchange control and discriminatory tariffs would continue for some more time post-war, it maintained that these measures should be soon ended.
The two significant accomplishments of the Bretton Woods Conference were the creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), also known as the World Bank.30,32
The IMF held the responsibility of maintaining fixed exchange rates based on the U.S. dollar and gold. The organization would contribute to orderly international monetary relations and the expansion of global trade by offering short-term financial assistance to nations facing temporary deficits in their balance of payments. The IMF also sought to address the balance of payments deficits caused due to long-term structural factors by modifying a country’s exchange rate.
Meanwhile, The IBRD was held responsible for the economic development of less developed countries and for financially assisting the reconstruction of war-struck nations. In July 1945, Congress officially passed the Bretton Woods Agreements Act, which authorized the U.S. entry into the IMF and IBRD. Both these key organizations began formally to exist on December 27, 1945.
Instead of valuing all national currencies related to gold, as in the gold standards, only the US dollar was valued in terms of gold. The value of all the other currencies was pegged to the U.S. dollar at a fixed rate. We can also say that indirectly, the value of all these currencies was fixed to gold.
The dollar returned to gold convertibility at $35 per ounce and began to serve as the world’s reserve currency.26 The Pound, the Franc, and other currencies were pegged to the dollar. This arrangement was designed to permit the recovery of world trade. At the same time, the General Agreement on Tariffs and Trade was ratified in 1948 to boost low tariffs and prevent a return to economic nationalism.31
Most of the countries joined except for the USSR. Treasury Secretary Henry Morgenthau persuaded the nation to join the Bretton Woods system, but the USSR chose to stay away from the new economic order.
An international gold market already existed, wherein the traders widely speculated on the value of the U.S. dollar. However, the Bretton Woods system depended on the U.S. dollar’s value to remain fixed in gold. So as the dollar saw excessive speculation, central banks had to intervene in the gold market to maintain the dollar’s peg to gold.
The US Treasury experienced a continuing drain on its gold holdings in the 1950s. There was constant pressure to increase the prices of gold. Towards the late 1960s, when the free market gold price topped $40, the US Federal Reserve and the Bank of England mutually agreed to sell a significant quantity of gold stored at the Bank of England to help the US reduce demand for gold reserves.
In 1961, eight large central banks created the London Gold Pool to control the gold price at $35/ ounce by coordinating the sales and purchases of gold.33 These nations contributed an aggregate of 240 tons (7.716 million ounces) to this Pool. The US allocated 120 tons or nearly 50% of the total. Germany contributed 27 tons, while The United Kingdom, France, and Italy provided 22 tons. Belgium, the Netherlands, and Switzerland each contributed 9 tons. The value of gold at that time was $270 million in the US.
By the end of the 1960s, the United States began to lose its power, which held tight for almost two decades. During the same time, Europe had rebuilt itself with minimal help from allies, while Japan transformed from a country that provided cheap, mediocre quality products to an emerging exporter of high-quality brands across the globe.
As other economies began to grow amid the capitalist boom, they became unhappy with the US Dollar as an international currency. Europe and Japan only looked at the US as their provider of defense and security, which became less of a priority as time passed.
After the Vietnam War, the American government saw a massive outflow of US Dollars from the American government. The country lost a cumulative $3 billion from supporting the London Gold Pool.
This was in sharp contrast to the post-world war II situation where the inflow of US Dollars was more than the outflow. The US Dollar was in massive supply worldwide, but the demand wasn’t as high as before. Therefore, the rate fixed to gold by Bretton Woods started to become overvalued against other currencies like Germany’s Deutsche Mark and the Japanese Yen.
US Presidents John F. Kennedy and Lyndon B. Johnson took various measures to sustain Bretton Woods and support the US dollar but to no avail.35 Some of these measures were foreign investment disincentives, curbs on foreign lending, restrictions on the US Dollar outflow, and international monetary reform. Other countries were against devaluing their currency against the US dollar to shoot up their export prices.
1967 came as a significant turning point in the history of the currency markets. In November 1967, the UK government devalued the sterling against the US dollar and came under excessive speculation. The central banks in the London Gold Pool took action to prevent the dollar’s gold peg from collapsing by resorting to a form of quantitative easing (QE).
The central bank bought enormous amounts of gold. However, the cost of saving the dollar was huge; therefore, in March 1968, the London Gold Pool was ultimately terminated after being shut for two weeks.
During this period, other markets traded gold at higher prices. The largest banks in Switzerland formed the Zurich Gold Pool, after which the city emerged as a major gold trading center.34 The London Gold Pool successfully stabilized the dollar’s gold price from 1961 to 1968 and prevented the Bretton Woods system from collapsing.
As the US government continued to increase the level of the money supply leading to higher inflation, West Germany withdrew from the Bretton Woods system in May 1971, while Switzerland and France did so in August 1971.
The market price of gold in dollars continued to rise higher in the meanwhile. The US had the option to sell massive amounts of gold to keep the dollar’s gold link or break the dollar’s peg to gold. On August 15, 1971, President Richard Nixon suspended the dollar’s convertibility into gold.
When President Nixon suspended the dollar’s gold convertibility, all currencies lost their link to gold. President Richard M. Nixon announced his New Economic Policy, also known as the “Nixon Shock.” This initiative was a death bell for the Bretton Woods system of fixed exchange rates.35
For the first time in history, currencies could be valued only in terms of each other. From that very moment, gold ceased to play a role in international foreign exchange. Instead, traders exchanged currencies directly and, thus, the modern forex market was born.
Inflationary Monetary Policy in the United States was a key reason for Bretton Woods’ collapse. Before that, the Federal Reserve Chairman, William McChesney Martin, successfully maintained low inflation.
At the start of 1965, the Martin Fed moved to an inflationary policy that continued until the early 1980s. The 1970s was the era known as the Great Inflation in the US.
The Bretton Woods system made it compulsory to follow monetary and fiscal policies consistent with the official peg. However, the US violated this rule after 1965.
When the U.S. unilaterally decided to devalue its dollar by 10% in February 1973, raising the price of gold to $42 per ounce, it was too much for the system.36 The fixed exchange rate regime established at Bretton Woods endured for the better part of three decades.
However, after February/March 1973, floating exchange rates became the norm for the currencies of the major industrialized nations.
The end of the Bretton Woods Accord paved the way for the Smithsonian Agreement in December 1971.37 The agreement was similar to the Bretton Woods Agreement, but it allowed for a greater fluctuation band for the currencies. The currencies moved in a wide range of 2.25% in either direction against the US Dollar compared to the 1% range from Bretton Woods. Under the Smithsonian Agreement, the US Dollar was pegged to gold at $38/ounce, thus devaluing the US Dollar to more than $70 per ounce of gold.
The Smithsonian Agreement was a temporary accord that came into effect in 1971 between 10 leading nations: the United States, the United Kingdom, Canada, Belgium, France, West Germany, Italy, Japan, the Netherlands, and Sweden.37 It became mandatory when President Richard Nixon abolished the exchange of US dollars for gold. This also marked an official end to the Gold standard.
The objective of the deal was to make adjustments to the fixed exchange rates established under the Bretton Woods Agreement and design a new standard for the dollar, as other leading nations were pegging their currencies to the US dollar.
In the Smithsonian Agreement, the US Dollar was pegged against other currencies. As a result, there was a partial devaluation of the U.S. dollar by 8.5% relative to gold. However, it wasn’t adequate to address the underlying issues of the Bretton Woods Agreement. The Smithsonian Agreement lasted just 15 months before the collapse of the broader system.
In 1972, the European community attempted to shift from its reliance on the US Dollar. West Germany, France, Italy, the Netherlands, Belgium, and Luxemburg then established the European Joint Float. After Bretton Woods, the Smithsonian Agreement also collapsed in 1973. Eventually, in March 1973, the world officially switched to the free-floating system of currencies.37
A free-floating system is one wherein the exchange rate is determined by supply and demand on the open market. A floating exchange rate doesn’t imply that the countries cannot intervene to adjust their currency’s price.
The country’s governments and central banks have the right to exercise discretion to regulate their currency price and keep it in a favorable spot for international trade.
Floating exchange rate systems mean that the long-term currency price fluctuates to reflect relative economic strength and interest rates between countries. On the other hand, Short-term movements in a floating exchange rate currency are based on the daily supply and demand for the currency besides the latest news or speculation.
If supply is more than the demand, currency price will decline, and if demand exceeds supply, then the current price would rise.
In addition to the free float exchange rate system, technological advancement also brought about a fundamental change to the history of the forex market. In the 1970s and 1980s, only the large banks and financial institutions indulged in forex trading; non-banks could only access the forex market via a banking relationship.
After the 1990s, forex trading became more decentralized, and even retail traders could participate in the forex markets. We will explain that in detail in a bit.
As the Bretton Woods Agreement had its foundation in the system of fixed exchange rates, the IMF had to amend its Articles of Agreement to allow floating exchange rates. In 1976, the Jamaica Agreement, held in Kingston, Jamaica, formalized the transition to the floating exchange rates system.38 After a series of negotiations between 1973 and 1976, IMF member countries agreed to alter fundamental aspects of the Bretton Woods system.
The IMF’s Board of Governors approved these changes on 8th January 1976 in Kingston, Jamaica, and it took two years for them to come into effect.39
This Jamaican Agreement legally allowed each member to float the value of its currency. It also terminated the par value gold-based system. The Jamaican accord also made provisions for financial assistance to developing G-77 or Group of 77 countries to compensate for any loss in export earnings of primary commodities.
Another impact of the collapse of the Bretton Woods Agreement was the creation of the European Monetary System. The currencies had begun to float, which resulted in fluctuation in market value relative to one another. This prompted members of the EC to seek out a new exchange rate agreement to address the requirement of their union.
In 1979, The European Economic Community introduced a new system of fixed exchange rates called the European Monetary System to boost closer monetary policy ties between members of the European Community (EC).40 The European Monetary System (EMS) aimed to end the significant exchange rate fluctuations between the member nations and stabilize inflation so that it is easier to conduct trade with each other.
The initial years of the EMS saw various challenges. The currency values were stronger, and the importance of stronger currencies increased while the weaker ones weakened further. After 1986, changes in national interest rates were explicitly used to keep all the currencies stable.
In the early 1990s, the EMS faced a new crisis. Varied economic and political conditions across the member nations and the unification of Germany prompted Britain to withdraw from the EMS. Later Britain, Sweden, and Denmark opted out of the Eurozone.
To curb the stagflation in the early 1980s, the erstwhile Fed Chairman, Paul Volcker, raised interest rates which led to a massive appreciation of the US Dollar at the cost of its competitiveness in the international markets.
As a result, the US current account recorded a deficit of 3.5% of GDP as the exporters were hard hit. Most American factories began to shut operations because they couldn’t compete with overseas competitors.
To address this issue, the G-5 countries – US, Great Britain, West Germany, France, and Japan – held a secret meeting at the Plaza Hotel in New York City in 1985. The nations reached the so-called “Plaza Agreement,” wherein major currencies decided to intervene in the exchange markets and appreciate against the US dollar.41
This program worked quite well in devaluing the US Dollar and curbing the current account deficit. The Plaza Accord dramatically increased the value of the Yen and Deutsch mark relative to the dollar. As an unfortunate consequence, Japan had to face nearly a decade of sluggish growth and deflation. To recover from this phase, Japan became less dependent on the US Dollar and increased its trade with East Asia.
On February 22, 1987, major G-6 countries, the United Kingdom, the United States, Canada, France, West Germany, and Japan, entered into a new agreement called the “Louvre Accord” to reverse the policies undertaken in the Plaza Accord.40
The countries agreed to stabilize the exchange rates and stop the US dollar’s decline. The Plaza Agreement and the Louvre Accord were instrumental in bringing stability to the US Dollar in the period between 1980 to 1987.
On 1 January 1999, twelve European countries entered Stage three of the Economic and Monetary Union. As a consequence, the national currencies of these countries merged into a single currency called the Euro.43
After February 28, 2002, the national currencies of the European Union member states ceased to be legal tender. The euro became the sole currency of the EU. The euro was conceptualized in the 1991 Maastricht Treaty, wherein the 12 member countries of the European Union created a single economic and monetary union.
The objective behind creating a single European currency was to boost trade by lowering prices and eliminating foreign exchange fluctuations. Today, the Euro (€) is the official currency of 19 out of 27 European Union countries. Together these countries are collectively known as the Eurozone. The Euro is the second most traded currency and accounts for 32.3% of all global trades.44
Experts argue that the Euro altered the forex market structure and enhanced market transparency through currency elimination.45
Deregulation of financial markets from the 1980s introduced advanced forex products in the market. Among these were hedging products that helped businesses manage foreign exchange risk even while dealing with volatile currencies. At the same time, derivatives created profit opportunities for traders.
In the 1980s, forex trading was conducted over the telephone. Thus, businesses and individuals would call a forex dealer, which would typically be a bank, and ask for real-time quotes for the currency pair they wished to trade. The quotes stated by the dealers helped the traders to take a call. The forex trade Confirmation was still done through the physical exchange of paperwork.
More than 50% of all forex trading was between dealers who called each other directly or used voice brokers and “squawk-box speakers” to place orders. Dealers depended on each other for correct market information and passed on less-demanded currency inventory through a process called “hot potato trading.”
However, from the late 1980s, technology brought about a massive transformation in forex trading. In 1987, Reuters introduced the first system to record inter-dealer trades and paired it with a screen displaying live price quotations. The system was called Thomson Reuters Dealing (line 5), and it principally replaced telephonic calls with typed messages.46
In the early 1990s, the currency markets became more sophisticated and faster due to the advent of the internet. Online forex trading platforms and electronic settlement replaced Telephones and paperwork in inter-dealer forex trading.
The forex market became more inclusive and open. Trade was possible even with currencies that were inaccessible due to political factors. Emerging markets like Southeast Asia also flourished due to the new form of forex trading.
In 1992, Reuters launched the first automated electronic brokerage system called Thomson Reuters Matching.46 Now, dealers across the globe could quote rates and trade anonymously with each other. With the increased adoption of the internet, more online trading platforms emerged. For the first time, individuals could get involved in foreign exchange trading through these automated platforms.
Officially, electronic trading for retail traders began around 1996. It was in this year that State Street launched its electronic platform, FX Connect.
As the US dot-com boom gained momentum in 1999, more banks began to offer electronic trading platforms for end-users. Currenex, launched in 1999, empowered customers to send a “request-for-quote” to forex dealers across the globe simultaneously.
The dealers had to respond within seconds, and the retail traders could choose dealers as per their wish. The option to place ‘limit orders’ on online platforms was indeed a revolution. Also, single-bank and independent multi-bank online forex trading platforms changed the equation between customers and dealers.
Now, customers could use price information supplied by dealers on the same platform and execute their own trades.
The forex market grew enormously between 2000 and 2010 due to the proliferation of electronic dealing platforms, types of brokerage, and the rise in retail participation. The share of electronic trading in the forex market rose from 2% in 1993 to nearly 20% in 2001.
However, the electronic trading system faced “ settlement risk” due to differences in trading hours across the globe. Hence, in 1997 a consortium of 74 banks began to conceptualize a new electronic settlement mechanism to address settlement risk.
The institutional-centric Forex market has become open to the masses with the growth of internet-based trading. The first generation of retail Forex brokers looked quite similar to online casinos and not stock or futures brokerage firms.
Just like the stock market’s, many of these early entrants to the online Foreign exchange market “bucketed” their customers’ orders. ‘Bucketing simply entails a broker confirming the completion of a requested trade without executing that order in reality. This was an attempt to manipulate prices and earn profits. Thus, the foreign exchange market became a place for speculative practices.
As electronic online forex trading evolved, it boosted transparency through real-time price quotes, and dealers could no longer manipulate prices to increase their profits.
However, as retail traders began to educate themselves, the operations in the foreign exchange market gradually improved. A few brokers started operating in an Electronic Communications Network (ECN) or straight-through processing (STP) business model by developing connections with more prominent banking institutions as trading partners or agents in some portions of the customers’ trade.
Eventually, the National Futures Association (NFA) and Commodity Futures Trading Commission (CFTC) were entrusted with regulating brokers in the foreign exchange market in the US. Financial regulators in the forex markets around the world took similar steps in establishing regulatory bodies.
The Financial Conduct Authority (FCA) in the UK, Financial Services Agency (JFSA) in Japan, and The Investment Industry Regulatory Organization (IIROC) in Canada are the associations that have been instrumental in bringing about fair practices in the foreign exchange market.
This incredible journey that the currency market has seen is a result of technological advancement and sound policy implementations. We have evolved from a barter-based economy to one that now features digital payments. From the manually-written accounting entries of the Bank of Amsterdam to the online trading systems that exist today, foreign exchange has indeed come a long way.
It will be interesting to watch out for more developments in this space, which are likely to be led by artificial intelligence, 5G technology, and mobile internet.