Floating Currency Pairs in a Global Market Was a Necessary Innovation
Floating Currency Pairs in a Global Market Was a Necessary Innovation
Today’s forex market was a natural outgrowth of financial innovation crafted in the twentieth century, driven by the reality of market forces and technological advances of the day. It is difficult to imagine a world without real-time market valuations of quotes for appropriate currency pairs for major currencies, but the extreme volatility of foreign exchange markets following World War II gave way to various accords to control currency rates by tight governmental decrees. The objective at the time was to encourage economic growth and prosperity on an international basis by preventing wild fluctuations in the primary currencies.
The Bretton-Woods Accord was the mechanism that was adopted to facilitate a stable rebuilding of Europe following World War II by pegging currencies and by creating the International Monetary Fund (IMF). Major trading currencies were tied to the value of the U.S. Dollar, the world’s first true reserve currency. Each currency was not allowed to fluctuate more than 1% on either side of the Dollar’s value, thereby requiring intervention by a central bank to force the value back within these tight constraints. The U.S. Dollar was then pegged to the value of Gold, $35 per ounce at the time and quite a bargain in today’s terms.
This tightly monitored system put an end to currency speculation. With the majority of the world’s industrial complex in ruins, Europe in shambles, and socio/political orders in disarray, currency volatility was the last thing that was needed for rebuilding global economies. A stable environment was necessary, not the old “standard” where governments of countries would permit their currencies to “float” in an “on again, off again” manner in order to yield to financial pressures. The resulting fluctuations would send shockwaves through global markets and dismantle many existing international trade relationships.
The IMF is a cooperative organization with 187 voluntary member states. The institution allows for orderly discussions between trading partners and how their respective currencies can be bought and sold to facilitate ongoing international commerce. Open communication on policies in this arena is believed to enable trade and economic growth for all concerned, thereby leading to increased employment and global prosperity. The IMF can also loan money to troubled members if they agree to implement economic reforms to address their problems at hand.
Attempts by mankind to control market forces by governmental edict have always tended to be temporary in nature. Over time, they break down and the market regains control. The Bretton-Woods Accord lasted twenty-seven years and achieved its objectives. Fixing the U.S. Dollar on Gold at $35 per ounce was rapidly depleting U.S. gold reserves and global confidence in the currency. The gap between economic growth and inflation was also widening, adding more pressure to the equation. President Nixon was forced to intervene and abandon the gold standard. Import surcharges were eventually dropped, and 2.25% replaced the 1% conversion band, yielding to full free market-floating currencies in 1976.
Over 50% of today’s $3.2 trillion daily market volume in currencies is between major commercial banks, so dubbed the “interbank” market. Retail forex trading did not come about until a creative fx broker realized that he could aggregate his trading volume and permit smaller contract units than the prevailing “1 million” unit requirement. Together with the Internet and sophisticated trading platforms, a handful of brokers then enabled the retail forex trader to join the global currency trading community, and a new history was born.
Currency conversion rates are the “fulcrum” between competing global economies. Appropriate valuations can only come from an active forum of global market forces.
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