Many people are unaware of the long and interesting history regarding exchange rates but in truth, movement of money is something that dates back thousands of years. Today, billions of dollars are exchanged between different currencies and now with the internet, making a trade or exchange has never been easier or faster. In fact, while money would have evolved anyway, technology has taken it to new heights.
If you look at modern currency trading, you would see that it is linked to the creation of money. In order for foreign exchange to exist, people have to agree that money has value but that it is also something available to purchase products and/or services. When looking at how money has value, it has historically been supported by some type of precious metal, specifically gold and silver.
By the 19th century, the majority of the world’s currencies being circulated were backed by gold bullion, which originated from England’s government. However, by the time the 20th century rolled around, the gold standard had seen change. At that time, the world saw the United States as being a superpower for the global economy, which allowed the US currency to be accepted around the globe for trade but also bartering. Interestingly, the United States dollar continues to dominate and of all foreign exchange transactions made, it is a key contributor in approximately 70%.
Coins used as currency can be dated to 2000 BC, a time when historians believe that coins made of metal consisting of silver and electrum were thought to have started in Asian Minor. Although the exact date is unknown, it seems this occurred sometime around the 7th century. Over time, the metals changed to copper, lead, bronze, and gold. The metals used to produce the first coin currency were rare, which meant after coins where minted, they had value. In fact, people who were fortunate enough to have coins would take them everywhere they went to keep their wealth close by and during the Roman era, coins had a hole punched in the center so they could be carried on a string or cord.
As far as paper money, historians believe this too started in Asia, sometime around 806 AD in China. The difference is that when paper currency was developed, it had no tangible value so backing by commodities was necessary, as well as the issuer’s credibility. Then for trading, paper currency made it possible to trade without people carrying around large quantities of coins. When paper currency was introduced, it also led to a problem of counterfeiting, which to this day, remains an ongoing problem.
Officials realized that the only real way for there to be value in paper money, currencies were eventually linked to stores of precious metals that were cautiously guarded. Known as the “gold standard”, bank notes being issued were linked directly to gold, a practice that started in England in 1816. Over time, it was determined that this practice worked, which led to the majority of currencies around the world using gold for backing to include the United States. However, with the stock market crash of 1929, currency dropped in value and the economy was devastated. Realizing risk of the gold standard, slowly a move away from this occurred.
Then in 1933, the then President Franklin Roosevelt filed an appeal whereby citizens and business owners of the United States would no longer be able to exchange paper money for gold but the foreign entities that held US dollars maintained right for an exchange to happen. Officials in the US realized the US dollar was gaining popularity and power, which led to the Gold Reserve Act of 1934 in which the Treasury Department would be allowed to get involved with the foreign exchange market through the Exchange Stabilization Fund to help with stabilization of the dollar.
With the start of WWII, the economy was being pressured around the world. Because of this, Europe was devastated. After the defeat of the Axis Powers, people knew that the US dollar would play a key role in getting the economy back on track. At this time, the allied nations met in 1944 at the Bretton Woods Conference, developing a gold-based exchange that would become known as the Bretton Woods System, with two organizations, the International Monetary Fund and World Bank to help rebuild the economy. By 1950, the German mark was again being exchanged and one year later, the Japanese Yen.
To help stabilize the world economy, the United States was providing massive quantities of money, which led to greater popularity. Gold reserves were still backing the US dollar internationally, which meant greater amounts of gold being exported to help with allied nations. In fact, by 1970, close to $45 billion was being held by foreign nations.
Then in 1971, a decision was made that the US dollar would no longer have backing to the gold standard, which is when the foreign exchange market was created, known as the “floating rate system” that allows for fluctuating exchange rates based on supply and demand. Today, most countries have dropped the Bretton Woods System, choosing the floating system instead.
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