History of Forex

Bretton Woods Agreement

In 1967, the Chicago Bank refused to make a loan in pounds sterling to Professor Milton Friedman, who planned to use the funds to sell British currency. Friedman believed that sterling was overvalued against the dollar and intended to sell the currency and then buy it back at a lower rate to repay the loan and make a profit. The bank’s refusal was based on the provisions of the Bretton Woods Agreement, made twenty years earlier, which fixed exchange rates against the dollar, and the dollar against gold, set at $35 per ounce.

The Bretton Woods Agreement was signed in 1944 to maintain financial stability in the world by limiting capital flows and currency speculation. Prior to this, from 1876 until World War I, the international economic system was based on the “gold standard,” in which currencies were tied to the price of gold. This provided stability by eliminating the practice of currency devaluation and inflation.

However, the gold standard had its drawbacks. Economic growth in one country increased imports, which reduced its gold reserves and reduced the money supply. This raised interest rates and slowed economic activity until a recession hit. Then prices fell, goods became attractive to other countries, causing gold to flow in, increasing the money supply and lowering interest rates, contributing to an economic recovery. Such cycles dominated until World War I disrupted trade flows and the free movement of gold.

After the two world wars, the Bretton Woods Agreement was established whereby countries pledged to keep the exchange rates of their currencies within narrow limits relative to the dollar and gold. Devaluation of currencies to gain trade advantages was forbidden, except up to a maximum of 10%. In the 1950s, with the increase in international trade brought about by the post-war recovery, there were significant capital movements that destabilized the exchange rates set at Bretton Woods.

In 1971, the agreement was finally abolished and the U.S. dollar was no longer convertible into gold. By 1973, the currencies of the major developed countries began to float freely, controlled by supply and demand in the international foreign exchange market. Trade volumes, speed and price volatility increased substantially in the 1970s, leading to the creation of new financial instruments and trade liberalization.

In the 1980s, with the advent of computers and new technologies, international capital movements increased, blurring the boundaries between Asian, European and American time zones. Trading volume in the international foreign exchange market grew from about 70 billion dollars a day (in the 1980s) to over 1.5 trillion dollars a day two decades later.

Euro market

One of the main catalysts for the development of the international foreign exchange market was the rapid expansion of the Euro-dollar market, where U.S. dollars were deposited in banks outside the United States. Other Euro markets developed in a similar manner when currencies were deposited outside their country of origin. The Euro-dollar market emerged in the 1950s when the USSR deposited oil revenues in dollars outside the US for fear of the US authorities freezing the accounts. This contributed to the significant growth of dollars out of U.S. control. The U.S. government enacted laws restricting the lending of dollars to foreigners. Euro markets were particularly attractive because of less regulation and higher returns.

Beginning in the late 1980s, U.S. companies began borrowing abroad, finding the Euro market advantageous for placing excess liquidity, obtaining short-term loans, and financing foreign economic activity. London was and remains the main center of the euro market. In the 1980s, British banks began actively providing dollars as an alternative to pounds in order to maintain their leading position in the global financial market. London’s convenient geographical location, allowing it to work with both Asian and American markets, also contributed to its dominance in the euro market.