The Foreign Exchange Market
is the largest and amongst the most liquid in the world. FOREX was originally
set up as a type of inter bank exchange that allowed currency conversion
between the banks. According to the Bank for International Settlements,
between $600 and $800 billion of foreign currency transactions were
traded per day in 1990. The FOREX market has grown dramatically
since then and is presently experiencing volumes of approximately
$4 trillion each day (Ref:
Bloomberg News 9.1.2010) . By comparison, a very busy day on the New York
Stock Exchange would equate to only $50 Billion USD in trading volume, or
less.
FX History
From 1870 to 1914 the
world's exchange system was operated under the Gold Standard System.
According to this system, all the world's currencies were pegged to
gold. This system worked well until the First World War when many
countries overprinted money in relation to their gold reserves in
order to meet the extraordinary economic demands at that time.
This consequently led to unprecedented inflation. As a result,
many European countries were forced to abandon the Gold Standard
System. In July of 1944, sixteen major western nations established the
International Monetary Fund ("IMF") to
supervise exchange rates and to establish a standardized system
for international payments. By agreement, the price of gold
was fixed (at US $35.00 per troy ounce) and a pool of reserves
was created by the member nations. Although market forces were free
to determine day-to-day exchange rates, the fluctuations were restricted
to plus/minus 1% of the agreed value.
Member nations had the power to intervene in order to ensure
that those restrictions were adhered to.
This system worked reasonably well until the 1960's when divergent
inflation rates seriously altered the relative competitiveness of the major trading countries.
In 1971 the US experienced a series of dollar crises, which caused the
collapse of the Gold Standard system. As a result, IMF came up with the Smithsonian Agreement,
under which the US dollar was devalued by 10% and a wider fluctuation band (between
1% and 2.25% above or below the official spot rate) was adopted.
By March of 1973 the Smithsonian Agreement also collapsed.
The outcome of these failures was to let member currencies free-float
in relation to each other, and thus the FX market as we currently know it was born.
