The History of the Forex Market

The History of the Forex MarketThe Nixon shock of 1971 spawned the establishment of the current foreign exchange market.

This foreign currency market was started in 1973 as a managed floated exchange rate system, but by 1978 the IMF ratified the free-floating of currencies.

An infantile form of foreign exchange trading history can be traced back to 1875 that precipitated the emergence of the gold standard monetary system. Prior to that, there was the gold exchanged standard that was the circulation of commodity money.

The gold standard monetary system meant that the US dollar was the currency that was pegged to gold at a rate of 35$ per ounce. Hence other countries were backed by the dollar. Any country with macroeconomic imbalances was allowed a ten percent adjustment, and outside of that limit had to get approval. This measure was too stringent for most countries handle, due to their uncompetitive edge and the balance of payment deficits that they racked up because of the inability to devalue their currencies as they like. The problem that was of concern to member countries was whether The US government could redeem all the dollars that there trading partners had accumulated, after World War 2 from commercial activities, from their gold reserve. Consequently, the monetary system proved to be unsustainable by the US government, due to the unprecedented demand on its gold reserve from member countries, and they had no choice but to abandon the monetary system.

After the collapse of the Bretton Woods Accord in 1971, the US turned to the Smithsonian Agreement, which in fact, was the agreement that ended the Bretton Woods Accord. The Smithsonian Agreement signed on December 1971, by the Group of ten, had little impact on the stability of the currency and by March 1973 the system was shelved. This led to a managed floating exchange rate system, as was mention earlier. It was the introduction of the free-floating of currencies that was mandated by the IMF, which led to its popularity and strong growth in 1978, accounting for a daily volume of 5 billion dollars. And in 1993 we had a worldwide free floating of currencies, due to the failure of the European Monetary System and prior to that, the European Join Float system which also failed.

The system of free-floating of currencies was the one to add a semblance of order in the market place. Many countries derived significant benefits from the system, such as the ability to expand or contract their own money supply to stimulate economic activates or to keep inflation in check.

The Forex Retail Interbank Market

The forex interbank market is the market that the large banks use to trade and the set prices, they are the market makers. Their importance can’t be discounted when it comes to the overall functioning of the foreign exchange market because this is where all the major currencies trades are channelled. And the smaller trades are channelled through the retail market facilitated by retail brokers. The main structures of the market are:

1.The Spot Market – is also known as the cash market, it is a public market where financial instruments are traded for immediate delivery. The architecture of this market mainly exists in cyberspace that accounts for 30% of the entire forex market volume. The market is decentralized, so there is no centralized record keeping apart from individual retail brokers, hence all transactions are done over the counter( OTC).

2.The Forwards Market – this is a spot market, over the counter transaction, where the delivery of the commodity is in keeping with the finalization of the contract. Farmers use this contract to ensure prices between parties before the harvesting of their crops, due to the volatility in the market and the uncertainty of future prices.

The forex market is the domain of the banks, large corporations and wealthy individual. The minimum transaction for a speculative trader then was one million dollars. The general public could not participate due to the high requirement. But around 1995 retail brokers started to offer smaller margin accounts requirement for speculative trader.

The Forex Market

The forex market constitutes the lower echelon of the market in which the interbank market is at the top. There is no physical market structure that exists like the New York Stock Exchange. So its domain resides in cyberspace, totally decentralised and over the counter transactions. But yet it is the largest market ever, accounts for a daily volume of 3.98 trillion dollars as of April 2010 and a growth of 20% over 2007, according to the Bank of International Settlement. The “mover and shakers” of the forex market rest with the large banks, such as UBS, Barclays Capital, Deutsche Bank and Citigroup. The other traders are financial institution, central banks,hedge fund and speculators. The forex market goes 24 hours per day five day per week; London is the centre for forex, second is New York and third is Tokyo. The forex market is regulated by NFA and CFTC. The main function of the market is to enable global trade and investment, through the ease of convertibility of currencies by businesses. The main activities of the market are speculation, commercial and hedging. The market also support carry trade, due to interest rate differential. For instance, an investor borrows at a lower interest rate from Japan and invests it in a higher yielding currency in the US.

The major currency pairs are the Pound Sterling; Canadian dollar; Australian dollar; Japanese Yen; Swiss Franc and Euro. The Canadian dollar and the Euro are negatively correlated, in fact the Yen, Canadian and Swiss all move in the same direction and the same is true for the others. The US$ is the main currency that is paired with all the majors, for example EUR/USD, GBP/USD.

Garth Simpson is a forex trader and a former investment banker. Presently, he runs his own online business. Forexcoach. visit: http://mygarthsimpson.com

 

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