Forex Trading Basics -- Tutorial 2 The History of Forex

In the last chapter, the topics covered the basics of Forex trading. Chapter two will cover an overview of the history of Forex and currency trading, in addition to the Bretton Woods agreement, the Gold Standard and the how modern Forex trading developed.

Bretton Woods and the Gold Standard

Currencies for individual countries were set in their exchange rates before the modern era of currency trading started. After July 1944 to 1971, each world trade currency was convertible into another current at an agreed upon rate. However, the US dollar was also fully backed by gold, making it the only currency in the world to have this extra insurance. For example, when a country like Switzerland held $10 million USD in their government’s reserves, they could agree to convert $10 million USD to currency or convert instead to gold bullion. Having a set standardized exchange rate of foreign currencies combined with the ability to use gold or USD currency interchangeably was called the Bretton Woods Agreement and Gold Standard.

Created out of the dire economic straits from the European conflicts in WWII, the Bretton Woods agreement helped establish the US dollar’s dominance as the reserve currency of the world because members of the international community filled their coffers with the US dollars that also had the guaranteed backing of US gold. Establishing an international financial agency, like the International Monetary Fund also helped to mitigate the challenges of broken and failing national economies.

US Dollar Fully Convertible into Gold at a Set Price

At this point, the price of gold was fixed, thanks to the main feature of the Bretton Woods agreement. Additionally, the fact that only US dollars would be fully convertible into gold combined to allow the international community to covert dollars to gold and back as needed by their individual government’s foreign currency policy.

The Bretton Woods Agreement also allowed many countries to buy and sell basic and needed commodities with US dollars. Crude Oil, Corn, Wheat, and Soy products are just a few of the necessary basic commodities that were priced in US dollars. In order to trade for these commodities, countries needed to have US dollars in large quantities available to buy and sell. The countries soon realized that it became essential to have large amounts of US dollars in circulation and in order to buy and trade these raw supplies and countries in large quantities the countries would need to stock pile surplus US dollars. In addition, the international community could take advantage of the exchange of gold, to diversity or even strengthen their country’s treasury reserves. By incrementally changing out the US dollars to gold, a country’s reserves could move away from the broad circulation of the US dollar. France’s Charles De Gaulle was one such leader who took this opportunity to convert US dollars to gold.

US Gold Reserves Became Depleted

The problem with the Gold Standard is that there was only a limited amount of gold. By the late 1970’s, the worldwide community had considerably depleted the United States’ gold holdings with the free exchange of gold for US dollars. Faced with a dwindling gold supply and the record breaking exchange rate, the US government declared that effective August 15, 1971, the “gold window” as it was referred to, would be “closed”. After this date, world nations would lose the ability to exchange US dollars for gold at a set rate. France, the UK, the Netherlands and many more countries that stock piled vast quantities of dollars via international trade would not be unable to convert them to gold after the deadline. After August 15, 1971, the set rate for gold (and the US dollar it was tied to) would change into a floating rate and rise and fall in accordance to the market demand.

The Jamaica Agreement in 1976

The modern currency market did not fully develop until the Jamaica Agreement went into effect in 1976. This agreement stated that the world’s currencies would float against each other without a set rate. All rates would move freely according to the market’s supply and demand, including currency pairs.

Up to now, Forex had only been utilized by central banks and large commercial banks and center mainly due to large contract size requirements and the limited market for currencies. The internet and the profusion of personal computers helped to jump start the retail level of Forex. High speed internet access connectivity and home computers created an instant worldwide community. Many countries sought to embrace the trading activity with pro-Forex broker/account holders by eliminating restrictions and difficult regulations that might hamper currency trading.

The newest technology infrastructure and strong financial regulation has helped to create a vibrant marketplace with many off and on shore Forex dealers and brokerages.

Today’s Players in the Forex Market

Today’s Forex market includes a variety of retail traders, small personal traders as well as large institutional traders. Unlike the national central banks that maintain their economies and regulate their treasury holdings via the currency market, hedge funds, mutual funds, endowment funds and individuals make the most out of the profits that are generated from trading in the Forex market. Forex traders worldwide have benefited from the level playing field that has been created by opening up access to the information, internet, software, and hardware requirements that profitable FX trading requires.

Next, chapter three outlines the pros and cons of trading Forex, as well the idea of diversification, leverage and small account minimums.

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1 Comment

  • James

    Reply Reply October 9, 2013

    Man I really need more time to understand the trading game.

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