Today’s Forex market is remarkable because of just how open and fluid it is. However today’s open Forex market did not just happen by accident. It didn’t happen overnight, either. Currency trading, as modern traders know it, developed in very specific steps over time. Understanding the history of the markets, where they were, and how they got to today’s open format will only make traders more appreciative (and more effective) in understanding how the markets work.
The Bretton Woods Accord
The Bretton Woods Accord took place in the 1940’s while World War II was still taking place and was an agreement that helped strictly regulate currency values and how one nation’s currency would be measured versus another. This agreement was for the United States, Canada, Japan, Australia, and most of Europe. The Bretton Woods agreement relied on both gold and the United States Dollar as a centrally accepted standard currency.
While this was expected to be the basis for currency trading and inter-market trading from then on, things would play out very differently in the real world where less than 30 years later it would be all but abolished. One important thing to understand right off the bat is that although many nations agreed to these standards, it doesn’t mean that every nation was happy with the rules and regulations.
From the very beginning, there were many nations looking for other options.
Euro Dollar & Soviet Acquisition Of Dollars
The term “Euro dollar” referred to the process of U.S. Dollars flowing out of the United States and into banks in other nations. This caused some stress on the United States economy, but it also happened often because of the Dollar’s place as a central currency and the fact that oil was tied to the U.S. Dollar as a currency.
The Soviet Union became a massive exporter of oil, which means that they received a major portion of this outgoing money. Since the Cold War was just heating up into full swing, they feared the U.S. freezing accounts that went to them for legally sold oil so they used European banks. This created the Euro dollar phenomenon and was the first major strike towards Bretton Woods.
Dealing With Inflation
The double whammy of increasing inflation and strongly increasing oil prices was hammering the U.S. Dollar and the U.S. economy. The natural reaction to this for international investors is to run to gold, since gold is always going to have value across virtually all markets.
This wouldn’t be a major issue in the current day markets, but since the U.S. was still at least partially on the gold standard at this point, the heavy investment in gold from foreign investors was hurting the Dollar and making inflation harder and harder to deal with.
Richard Nixon & Free Markets
This scenario resulted in Richard Nixon declaring the U.S. Dollar completely off of the gold standard. In doing so he had to set the price, and the dollar was set at 1/35th an ounce of gold in an attempt to prevent inflation from getting completely out of control. This was an effective end to the Bretton Woods Accord that had been the force behind pegged currencies.
This release of the U.S. Dollar from gold resulted in a free market for major currencies. Markets would have far more control over the value of any individual currency and this basically opened up the door for the modern Forex market, although the markets today look far different than in 1971 for a variety of reasons, both obvious and some not so much.
Changing Technology Opened Up Markets Even More
The Chicago Mercantile Exchange (CME) was actually the first trading exchange that gave the option of currency trading after these changes. Known as the International Money Market (IMM), this paved the way for more exchanges to follow, but it would be the move to over the counter (OTC) trading independent from location that would really open up the possibilities in the modern Forex.
The movement in computer technology and especially the Internet would open up the Forex market to become a true global market that was open to traders everywhere who wanted to take advantage of leverage from their own home to trade currencies and take their chances with making a profit.
The Modern Market
With so many online brokers and the ability to make nearly instantaneous trades or decisions because of real time online software, modern currency trading is the absolute definition of an open market. It has no resemblance to the early markets that followed the Bretton Woods Accord, and most traders and commercial banks agree that this is progress for the better.
This is how the Forex market evolved from pegged currencies stuck in value to an open trading market for all major currencies.