Many centuries ago, the value of commodities was expressed in terms of other goods. This type of economics was grounded on the barter system among individuals. The obvious limitations of such an economic system spurred people to invent more generally accepted mediums of exchange. It was essential to estimate something as a common base of value. In some economies, different goods served for such purpose-mainly agricultural goods like cattle, furs and grain. Gradually, some precious metals, in particular gold and silver, established themselves as an accepted means of payment as well as a trustworthy storage of value.
Coins were originally minted from different precious and semi-precious metals: bronze, gold, copper, silver, etc. During the Middle Ages paper money were introduced in Europe and also gained acceptance. The precursors of contemporary’s modern currencies were the promissory notes, informal documents acknowledging monetary obligations. In 1696, Bank of Scotland became the first commercial bank in Europe to successfully issue paper money.
Prior to the World War One, most currencies were pegged to gold, which ensured their convertibility. It was possible to exchange freely paper money for gold.
Moreover, it was not necessary a Centrals bank to have full gold coverage of the state’s currency reserves. However, when a group mindset fostered the disastrous idea of converting back to gold on a mass scale, such panics led to the one referred to as “Run on banks.” The mixture of a greater supply of paper money without enough gold as coverage resulted inevitably in devastating inflation picks and political instability.
In July 1944, the Bretton Woods agreement was reached on the initiative of the United States of America. The conference rejected the proposal of John Maynard Keynes for a new world reserve currency in favor of a system built on the US Dollar. International institutions as the IBRD (now the World Bank), the International Monetary Fund and GATT were created in the same period as the emerging victors of WWII looked for a decision to avoid the destabilizing monetary crises and rebuilding their post-war economies. The Bretton Woods agreement imposed a system of fixed exchange rates based on the Gold Standard partly, fixing the US Dollar at $35.00 per one ounce of gold and fixing the other currencies to the dollar, initially planned to be on a constant basis.
During the 1960’s, the Bretton Woods system came under pressure as national economies moved in different directions. A number of reorganizations kept the system viable for an enduring period but finally Bretton Woods system collapsed in the early 1970’s, following President Nixon’s unilateral suspension of the gold convertibility in August 1971. The dollar lost its convertibility to gold and came under constant pressure from the increasing US budgetary and trade deficits.
In 1979, the European Economic Community introduced a new fixed exchange rate system, named the European Monetary System. The EU pursuit for currency stability led to the Maastricht Treaty; its aim was not only to fix exchange rates but also to replace many of the member counties currencies with one single currency- the Euro. Up to the present, Europe has introduced the Euro in seventeen member countries. The physical initiation of the Euro took place on January 1, 2002.
In the last few decades the restrictions on capital inflows and outflows have been removed in most countries, leaving the market forces to adjust Forex exchange rates according to their perceived exchange values.
While producers had to struggle with the increased currency exchange volatility, the investors and financial institutions have discovered a new playground. The size of the Forex market now goes beyond any other investment market. The currency rates volatility led to development of numerous hedging strategies and increase of derivatives utilization.
The onset of electronic trade in the 1980s accelerated the deals and facilitated cross-border capital movements through Asian, European and American time zones. Foreign currency transactions increased intensively from nearly $70 billion a day in the 1980s to more than US$4 trillion a day three decades later, thus forming the most liquid global market.