The History of Foreign Exchange is More Recent than Most Think

The world of floating exchange rates is often taken for granted as a current institution with a long history, but today’s forex market that transacts over $4 trillion daily is a recent phenomenon.  Retail forex trading is relatively young by most standards, actually evolving out of the nineties as forex brokers creativity and technology converged to make it a reality.  Prior to that time, lot sizes were $1 million an up, such that only major international banks could tread in those waters.

Floating exchange rates came about in the seventies, following a protracted period of industrial redevelopment that commenced after the end of World War II.  The Bretton Woods Agreement was implemented after the war to prevent wild gyrations in the currency markets that could dampen the global rebuilding effort that was underway.  Major currencies were “pegged” to the U.S. Dollar, which in turn was “pegged” to a fixed amount of Gold, $35 per ounce, the so-called “Gold Standard”.  Trading ranges of one percent were enforced daily by the central banks, which, over time, became constrictive for many participants.

Artificial systems rarely work for extended periods of time, and neither did Bretton Woods.  The agreement did provide the necessary stability, but Gold reserves in the United States were declining rapidly, and differences were appearing in both GDP and inflation growth rates that supported greater variances in the existing rate structures.  Other artificial structures were tried that expanded the various rate fluctuation bands, but the true answer was to abandon the Gold Standard and pave the way for free floating rates.

In 1971, President Nixon suspended the Gold Standard by closing the Gold “window” to the rest of the world.  Nations were paid with U.S. Treasury Bills, backed by the strength of the U.S. Government alone.  The printing presses were activated to pay down foreign debt, but foreign governments tried to distance themselves from the Dollar by establishing regional floating arrangements.  The various processes formed the basis by the end of the decade for the floating currency markets that we have today.

The level of volatility in daily market action astonished officials, thereby leading to active forex trading by major global banks and financial institutions.  The seventies then represented the time when currencies rebalanced, producing a bear market for the Dollar that lasted until 1978.  Inflation and high interest rates immediately brought an influx of foreign capital into the States, leading to a bull market trend that continued until 1985.

Reaganomics and deficit spending began to weigh heavy on Dollar interests, yet the global community, expecting a weaker Dollar, was perplexed by the resilience of the greenback that refused to weaken.  A concerted effort by traders, banks, and industrial giants, known as the “Plaza Accord”, lead to ten years of dumping the Dollar until the desired balance was reached in 1995.

From 1995, it was “Bull Run” once again, a major strengthening trend that lasted until 2002.  The “Bear Fall” that followed lasted for six years until the recent recession stalled the downward motion.  All toll there have been five major trends for the U.S. Dollar from 1978 to 2008.  What about more current history?  For that answer, we turn to a Dollar index that is restricted to a few major currencies.

In the past three years there have been four major trends.  The “rollercoaster” continues, but on a much more quickened pace.  The era of globalization is upon us, and it is reshaping global currency markets as well.

Daniel Burkhart is a trader, writer and part owner of  air condition repair palm coast