Forex trading as we all are aware is very exciting and attractive market. Despite the high risk involved in forex trading, the fact remains that the traders are always fascinated by forex market. Forex Trading was, in the beginning, not meant for everyone and it required large account sizes and only the large investors, banks or financial institutions used to trade in forex market. Initially forex trading was only thought to be an exchange rate between the banks but the introduction of mini accounts have made it possible for traders of small account sizes to trade in the market as well. The recent advancements in technology has also helped a lot and now a trader can trade from its home, office or anywhere using internet and mobile technologies.
These days we can see news channel giving updates on foreign currency exchange rates but in the beginning forex trading was different. As Goods and Gold etc. were exchanged for one another and people used to travel from one place to another to exchange the Goods they had with the goods they wanted. As the trade expanded between the countries, Gold became the main source of exchange and remained a standard from 1879 to 1934. Price of everything was determined against the weight of Gold. On the Government level, it was necessary to acquire the amount of gold equal to which they can print and circulate money in their country and in case they print more money, the value of the money descends. Similarly for the countries to conduct import and export with other countries, they had to maintain a certain stock level and with transfer of currency, the gold had to be attached with it.
The main issue with using Gold as a standard was that in case the country has low exports and more imports than it can quickly reach a stage where its Gold reserves are gone and the country’s economy is badly affected.
Introduction of Bretton Woods
The leaders of the allied nations met at Bretton Woods, New Hampshire in 1944, to set up a better system of fixed exchange rates. The U.S. dollar was fixed at $35 per ounce of gold and all other currencies were expressed in terms of dollars. Not only that the Bretton Woods system also introduces the adjustable-peg system so that under some special circumstances, the exchange rate can be altered and to affect this system, International Monetary Fund (IMF) was created.
Under this new system, the currencies of all countries are defined in terms of their value against dollar and based on those rates, the rates between different currencies are determined. Each country maintains an account with IMF that is proportional to the country’s population, volume of trade, and national income.
The factors that affect the exchange rate of a country were the Gold reserves, the loans and money borrowed from IMF and some economic indicators. When the imbalances became too large, a country could adjust its rate to no more than 10% of the current value-any larger adjustment required the approval of the IMF board. This prevented countries from devaluing their currency for their own benefit.
The Bretton Woods system starts failing in the 1960s, when foreigners accumulated large amounts of U.S. dollars from post-World War II aid and sales of their exports in the United States. There were concerns as to whether the U.S. had enough gold to redeem all the dollars.
With reserves of gold falling steadily, the situation could not be sustained and the U.S. decided to abandon this system. In 1971, President Nixon announced that U.S. dollars would no longer be convertible into gold, so the exchange rate was allowed to float. Because of the central role played by the United States, the Bretton Woods system could not be sustained. By 1973, this action led to the system of managed floating exchange rates that exist today. The floating exchange rates that exist today are more of controlled by central banks.