We spoke briefly about the Bretton Woods agreement earlier, but the history of forex trading is believed to originate centuries before that period. The act of exchanging currencies could be centuries old, dating back to the Babylonian period.

Today, the forex market is one of the biggest, most liquid and accessible markets in the world, and has been shaped by several important global events – including Bretton Woods and the gold standard.

While it seems that the industry rules are already established, nothing is ever set in stone, and similar events could occur again in the future, thus impacting the trading landscape. After all, history tends to repeat itself.

This lesson will help you understand the key historic events which have shaped this market.

Timeline of key events that shaped the forex market

Throughout history, we’ve seen major events that have greatly influenced the forex trading environment. Here are some highlights:

• 6th century BC: first gold coins are created
• 1819: England formally adopts the gold standard
• 1834: America begins using the gold standard
• 1870s: major countries like France, Germany and Japan join the gold standard
• 1914-1971: the Bretton Woods agreement comes into play
• 1973: countries officially switch to the free-floating financial system
• 1985: the Plaza Accord is established by finance ministers from major countries, and the US dollar is depreciated
• 1992: the Maastricht Treaty is signed, ultimately leading to the development of the eurozone
• 1996: online trading begins
• Today: forex trades in large volumes of around $6.6 trillion a day

Where it all began (approximately 6th century BC)

The barter system is the oldest method of exchange and began as far back as 6th century BC, introduced by Mesopotamian tribes. Under this system, goods were exchanged for other goods.

As time went on, products like salt and spices became popular mediums of exchange. Ships would sail to barter them in the first ever form of foreign exchange.

Eventually, as early as 6th century BC, the first gold coins were produced. They acted as a currency because they had critical characteristics: portability, durability, divisibility, uniformity, limited supply and acceptability.

Gold coins became widely accepted as a medium of exchange, but they were impractical because they were heavy. In the 1800s, countries adopted the gold standard.

The gold standard guaranteed that the government would redeem any amount of paper money for its value in gold. This worked fine until World War I, where European countries suspended the gold standard to print more money to pay for the war.

The foreign exchange market was backed by the gold standard at this point and during the early 1900s. Countries traded with each other because they could convert the currencies they received into gold.

The gold standard, however, could not hold up during the world wars.

The Bretton Woods system (1944-1971)

The first major transformation of the foreign exchange market, the Bretton Woods system, occurred toward the end of World War II.

Delegates from 44 different countries gathered at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire to design a new global economic order.

The location was chosen because at the time, the US was the only country unscathed by the war – most of the major European countries were hugely affected.

In fact, after the stock market crash of 1929, WWII vaulted the US dollar from a failed currency to the benchmark by which most other international currencies were compared.

The Bretton Woods accord was established to create a stable environment by which global economies could restore themselves. It attempted this by creating an adjustable, pegged foreign exchange market.

This describes an exchange rate policy whereby a currency is fixed to another currency. In this case, foreign countries would 'fix' their exchange rate to the US dollar, while it was being pegged to gold.

As the US held the most gold reserves in the world at that time, foreign countries would transact in the currency (this is also how the dollar became the world’s reserve currency).

The Bretton Woods agreement eventually failed because there was not enough gold to back the amount of US dollars in circulation following increased government lending and spending, which led to more money being printed.

In 1971, President Richard M. Nixon ended the Bretton Woods system, which soon led to the free floating of the US dollar against other foreign currencies.

The beginning of the free-floating system (1973)

After the Bretton Woods accord came the Smithsonian agreement in December of 1971. While the two have some similarities, the Smithsonian system allowed for a greater fluctuation band for currencies.

The United States pegged the dollar to gold at $38/ounce, thereby depreciating it. Under the Smithsonian agreement, other major currencies could fluctuate by 2.25% against the dollar, and the dollar remained pegged to gold.

In 1972, Europe tried to move away from its dependency on the US dollar. The European ‘joint float’ was then established by West Germany, France, Italy, the Netherlands, Belgium, and Luxemburg.

Both agreements made mistakes like the Bretton Woods accord, and in 1973, collapsed. These failures resulted in an official switch to the free-floating system.

The Plaza Accord (1985)

In the early 1980s. the dollar had appreciated greatly against other major currencies. This was hard on exporters, and the current US account subsequently ran a deficit of 3.5% of GDP.

In response to the stagflation that began in the early 1980s, Paul Volcker – a famed American economist who was the chairman of the Federal Reserve (The Fed) at the time – raised interest rates. This caused the US dollar to rally (and decreased inflation) at the expense of the US industry’s competitiveness in the global market.

The weight of the US dollar was crushing third-world nations under debt and also led to the closing of American factories as they could not compete with foreign competitors.

In 1985, the G5 – being the US, Great Britain, France, West Germany and Japan – sent representatives to what was supposed to be a secret meeting at the Plaza Hotel in New York City.

News of the meeting leaked, forcing the G5 to make a statement encouraging the appreciation of non-dollar currencies. This became known as the ‘Plaza Accord,’ and its impact caused a swift fall in the dollar.

It didn’t take long for traders to realize the potential for profit in this new world of currency trading. Even with government intervention, there were still strong degrees of fluctuation. And where there’s fluctuation, there’s potential profit to be made.

This became clear a little over a decade after the collapse of Bretton Woods.

Establishment of the euro (Maastricht Treaty, 1992)

After WWII, Europe forged many treaties designed to bring countries of the region closer together. None were more prolific than the 1992 treaty referred to as the Maastricht Treaty, named for the Dutch city where the conference was held.

The treaty established the European Union (EU), led to the creation of the euro currency and put together a cohesive whole that included initiatives on foreign policy and security.

The treaty has been amended several times, but the formation of the euro gave European banks and businesses the distinct benefit of removing exchange risk in an ever-globalized economy.

The advent of online trading (1996)

In the 1990s, currency markets grew more sophisticated and faster than ever because money – and how people viewed and used it – was changing.

A person sitting alone at home could find, with the click of a button, an accurate price that only a few years prior would have required an army of traders, brokers, and telephones.

These advances in communication came during a time when former divisions gave way to capitalism and globalization (eg the fall of the Berlin Wall and the Soviet Union).

For forex, everything changed. Currencies that were previously shut off in totalitarian political systems could be traded. Emerging markets, such as those in Southeast Asia, flourished, attracting capital and currency speculation.

Forex trading today

Today, the forex market is one of the largest markets in the world. The history of forex since 1944 presents a classic example of a free market in action.

Competitive forces have created a highly liquid marketplace. Spreads have fallen dramatically with increased online competition among participants.

Individuals trading large amounts now have access to the same electronic communications networks used by international banks and merchants.