Broker’s Blurb : EVOLUTION OF CURRENCIES

Currency plays a very vital role in today’s era. It may be in the form of hard cash or plastic money. Currency means money and is important in an individual’s life because it is required for exchange of goods or services. This factor makes money a unit of account which can be used to value your assets and liabilities. The foreign exchange market popularly known as FX or currency market is a global decentralised market for currency trading. It is more properly defined as a market wherein participants are able to buy, sell, exchange and speculate on currencies. With regard to volumes, it is the biggest market in the world.

As per the Bank for International Settlements (BIS), trading in OTC derivatives’ foreign exchange markets averaged around USD 5.3 trillion per day in April 2013, having risen from USD 4 trillion and USD 3.3 trillion during the same period in 2010 and 2007. The most actively traded instruments in April 2013 were foreign exchange swaps at USD 2.2 trillion per day followed by spot trading at USD 2 trillion per day.

Evolution of Currency Trading

Currency trading and exchange first took place in ancient times during the barter system days. People used to help others to change money and charge a commission or fee on the same for their living during the Talmudic times. These people, who were popularly known as Kollybistes, used city stalls, feast periods in temples and the courts of gentiles. A majority of those involved in this process were silversmiths and goldsmiths. The Byzantine government held a monopoly for the exchange of currency during the fourth century.

During the ancient period, currency exchange played an important role so that people were able to buy and sell items like food, pottery, raw materials, etc. For instance, if a Greek coin contained more gold than an Egyptian coin because of its size or content, a merchant could barter a few Greek gold coins for a larger number of Egyptian coins or goods. As a result of this trading in history, most world currencies in circulation today have a fix value or specific quantity as per the recognised standard of gold and silver.

Coming to the 15th century, bank accounts were opened at foreign locations by the Medici family in order to exchange currencies on behalf of textile merchants. To facilitate trade, the banks created ‘nostro’ which was a form of accounting that contained two columns - one of foreign currencies and another of local currencies with information pertaining to any particular account with a foreign bank. In the 17th and 18th century, Amsterdam had an active forex market and in the year 1704 foreign exchange used to take place between agents acting in the interest of nations like England and Holland.

The Changing Currency Scenario

The early modern era started post the 18th century in which Alex Brown & Sons started to trade in foreign exchange in 1850. They were one of the leading participants in the US during that time. In 1880, JM do Espirito de Silva applied for a foreign exchange license and got engaged in the trading business. The same year marked the beginning of the gold standard. Before World War I there was limited control on international trade and later on many of the countries, during the years of the war, abandoned gold as a standard monetary system.

During the years 1899 to 1913, holdings of foreign exchange countries rose at an annual rate of 10.8 per cent. However, at the same time, the holdings of gold grew at an annual rate of 6.3 per cent between 1903 and 1913. During the closing year of 1913, about half of the global foreign exchange was on the basis of sterling pound. The total number of foreign banks operating within London was three in 1860 which increased to 71 in 1913. During the earlier years of the 20th century, foreign exchange trade was mostly active in Paris, New York and Berlin, while Britain was less involved in trade until 1914. Between 1919 and 1922 the employment scenario in foreign exchange in London jumped to 17 while by 1924 there were 40 firms operating for the sole purpose of trading of foreign exchange. In 1920, new trading in London reflected modern manifestation and by 1928 forex trade was considered an integral part of financial operations.

Currency System Post World War II

After World War II, the Bretton Woods Accord, arising out of the Bretton Woods conference, allowed trading in currencies with fluctuation in a range of 1 per cent to the currencies at par. In 1954, Japan changed the rules under Foreign Exchange Bank Law so that Bank of Tokyo became the centre of foreign exchange by September of the that year. Between 1954 and 1959 a Japanese legality was drafted to allow inclusion of more Occidental currencies in Japan’s forex. Thereafter, a free floating currency system was introduced by US’ president Richard Nixon which brought an end to the Bretton Woods Accord and fixed the rates of exchanges. After the ceasing of the Bretton Woods Accord’s enactment in 1971, the Smithsonian Agreement allowed trading up to a range of 2 per cent.

During 1961-62, foreign operations by the US Federal Reserve were comparatively very low. Between 1970 and 1973, the amount of trade taking place in the market rose three-fold. However, sometime between February and March 1973 some of the markets split as a two-tier currency market was introduced with dual currency rates. This was however abolished in March 1974. Reuters introduced computer monitors in 1973 which replaced telephones and telex previously used for trading quotes.

The ineffectiveness of the Bretton Woods Accord and the European Joint Float forced the forex markets to close during 1972 and 1973. A major junk of purchases of dollars took place in 1976 when the West German government acquired USD 3 billion. This event indicated the impossibility of the balancing of exchange stabilities by the measures of control used at that time and the monetary system and foreign exchange markets in West Germany and other countries within Europe were closed for two weeks.

In 1973, banking trade and controlled foreign exchange ended and complete floating took shape with relatively free market characteristics. On January 1, 1981, the People Bank of China allowed some domestic enterprises to participate in foreign exchange trading. That same year the South Korean government ended forex controls for the first time and granted permission for free trade. In 1988, a majority of the countries accepted the International Monetary Fund (IMF) quota for international trade.

A major chunk of worldwide trades during 1987 were within the United Kingdom followed by the US. In 1991, the Republic of Iran changed international agreements with some counties from the barter system of oil to foreign exchange. In the present scenario the foreign exchange market is more organised and has a larger geographical dispersion. It is a continuous operation that works for 24 hours a day except during the weekends. The trading starts from 22:00 GMT on Sunday (Sydney) to 22.00 GMT on Friday (New York). In the next series we will be covering the market size of the foreign exchange markets, liquidity scenario, and major market participants.