Wednesday, February 29, 2012

Foreign Currency Exchange Origins


     How did foreign currency exchange come about? The foreign exchange market that the retail currency trader knows today, has been shaped by a long history of global historical events. Consequently, studying the history of foreign currency exchange can be a lengthy and time consuming process. Although important for cultural and historical reasons, a detailed study of specific historical events like the Bretton Woods accord and the Smithsonian Agreement is not very useful for the modern foreign currency exchange trader. It is more important for a trader that is considering foreign currencies, to understand the logic behind foreign exchange as an efficient medium of exchange for goods and service.

      The barter system was originally used by our ancestors as a means of exchange. Bartering was inefficient as an exchange mechanism because it required that a lot of time be spent in negotiation to strike a deal. Also, much time was needed to search for the goods required for bartering. The barter exchange system was eventually enhanced by the public acceptance of standardized sizes and grades of metals like gold, silver and bronze for the exchange of merchandise. This metal currency for exchange had many advantages including durability and storage. During the middle ages, a variety of paper IOU's started gaining popularity as a medium of exchange.

Throughout the years, people began to realize that carrying around paper currency was a lot more advantageous than carrying heavy bags of precious metals. Consequently, stable governments eventually adopted paper currency and backed its value with gold reserves. This led to the birth of the gold standard. On July of 1944, the Bretton Woods Accord pegged the US Dollar to gold at a price of $35 per ounce. The Bretton Woods Accord also fixed other foreign currencies to the dollar. It lasted until 1971, when US president Nixon let the dollar "float" freely against other foreign currencies and suspended the conversion to gold.
      As we fast forward to the present, the foreign currency exchange market has grown into the largest financial market in the world, with an aggregate daily volume of 1.5 trillion dollars or greater. Even though foreign exchange has traditionally been an institutional (Inter-Bank) market, the growth of the Internet has propelled online currency trading among private individuals to the stratosphere, widening the retail currency trading market considerably.

1 comment:

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