Understanding History of Forex Market

What is Forex Market?

Trade the Forex (forex) – from the English Foreign Exchange reduction (translated as the international exchange or international exchange) is a collection of various trade, investment and speculative operations with currency, is implemented through a system of institutions.

Sometimes abbreviation FX is used for brevity.

Formally, the Forex market is not organized as a stock exchange . On the contrary, it is an informal network of trade relations between participants around the world, which include central banks, commercial banks, investment banks, brokers and dealers, pension funds, insurance companies, transnational corporations and various private investors. All major currencies are traded in this market. The main role in the Forex market belongs to banks that are called market makers of the Forex market, since they are the ones who make active trading operations, offering to buy or sell currency to their customers and counterparty banks.

History of Forex – Bretton Woods Agreement

Prior to the Bretton Woods Agreement, the international system of exchange rates was based on the postulate: money reversible in gold, have the price of gold. Most of the money was not directly convertible to gold, but reversible in other money: the pound and the dollar, which in turn are already exchanged for gold. In connection with the ongoing economic crises, and after the Second World War, even before its end, the allied governments agreed on the principles of cooperation in support of post-war trade and monetary relations.

Already in July 1944, when the Second World War entered the decisive stage, a meeting was held in Bretton Woods (New Hampshire) on the reform of the traditional system of gold standards of national currencies by representatives of 41 countries whose national currencies were most heavily weighted in international settlements.

Due to the fact that after World War II, the US economy was the least damaged of the developed countries and the United States was almost a monopoly in the market of gold (on the application Morgenthau – Minister of Finance of the United States – in 1944 under US control were more than 2/3 of the world’s reserves of gold) , only the United States could guarantee the exchange of its currency for gold at a declared rate (by 1948, the US gold reserve was already 3/4 of the stock of all market economies in the world).

According to the results of the Bretton Woods meeting, the US currency – the dollar along with gold was used as a reserve currency (the nominal value of the currencies of the member countries of the system was set in US dollars or gold).

In order to maintain the system of international payments, in 1944 an organization was created – the International Monetary Fund (IMF) . Under the agreement on the creation of the IMF, all countries participating in the fund established the nominal value of their currency in US dollars. The Fund lent, if necessary, the member countries to correct the balance of payments deficit.

The means of calculating between the countries was gold and the dollar. (According to article 4 of the IMF statute: each country is an IMF participantmust report its monetary parity in gold or in US dollars “in balances and in samples used on July 1, 1944). The dollar was recognized as an international means of payment, becoming in fact the only equivalent of gold, and therefore virtually all world prices began to be set in dollars The central banks of the IMF countries could convert dollars into gold at a fixed rate (the conversion was made by the US monetary authorities).

The US has committed to keep fluctuations in gold prices within + or – 1% of the price at $ 35 per ounce ($ 1 = 888.671 mg of gold) and exchange the dollar for gold at $ 35 per ounce (1947), and other countries – to keep fluctuations of national currencies within + or – 1% of the approved face value by currency interventions.

States under the agreement were given the right to devalue or revaluate their national currency, but if it was more than 10% of the declared parity, the IMF’s prior approval, which could be given, only if the balance of these countries came into so-called “fundamental disequilibrium” is necessary. However, in connection with the need for sudden devaluation (not sudden devaluation does not make any sense), in practice, permission was never asked (devaluation of the pound in 1949, the French franc in 1948 and 1969, etc.).

In general, in the beginning, it was more profitable for countries to keep their reserves in dollars compared to gold, since investments in dollar bonds brought an additional interest income.

However, the system of fixed exchange rates contained a serious contradiction. On the one hand, the dollar should have the same confidence as gold, it must have a fixed rate, so that everyone would not care about storing gold or a dollar. To this end, the issue of the dollar should be provided by the US gold reserve (otherwise there will be a crisis of confidence).

On the other hand, the US dollar should be issued in quantities sufficient to provide an increase in the international money supply for servicing an increasing number of international transactions.

This contradiction eventually broke into the system of the gold and currency standard. By the end of 1964, the dollar reserves of central banks had reached the size of the US gold reserve and, thus, the theoretical threshold of inconvertibility had been reached. Between 1960 and 1970, the reserves in the dollars of other countries tripled (47 billion dollars in 1970, in the same year the US gold reserve was 11.1 billion dollars). During the same period, the US gold reserve declined due to the requirements to exchange dollars for gold (in 1960 the gold reserve of the US was $ 17.8 billion). There was a lack of confidence in the US in their ability to exchange dollars for gold at a fixed rate.

Already in 1965, France made a massive exchange of its dollar reserves for gold, coming out of the gold pool of seven countries that pledged to maintain the price of gold. Private banks in Europe began to strike a blow to the system, making billions of dollars in exchange for the Fed.

In November 1967, the pound sterling was devalued. On March 17, 1968, central banks of a number of European countries abandoned attempts to stabilize the free gold market.

August 15, 1971, the Fed stopped converting dollars to gold central banks, and the limit fluctuations in the nominal value of currencies against the dollar was set at 2.25%.