What is the Forex market?
Let’s understand what we call the Forex market right now. The Forex market is an abbreviation for Foreign Exchange market, namely a market where currencies are traded. The Forex market is the largest international financial market in the world. Its daily turnover is from 5 to 7 trillion dollars. At the same time, the market is dominated by giant players, such as international banks, hedge funds, and transcontinental corporations. There are lots of individual traders on the market.
In the Forex market, currencies are traded in pairs. You can trade the EUR/USD pair and exchange euros for dollars at the market rate, or trade GBP/JPY and accordingly exchange pounds for yens and vice versa. The profit that traders and market participants can receive is based on exchange rate changes and market fluctuations, so traders try to buy currency at the lowest price and sell at the highest.
Market fluctuations depend on many factors, including the interest rate set by central banks, prices on raw materials markets, the political situation, etc. That means the price of a currency is formed by several factors, but this was not always the case.
Let’s find out when and how the Forex market appeared, what are the stages of its development and why it looks like this now.
What is the Bretton Woods system?
Let’s go back to the time before the Forex market existed and find out how international financial relations were organized. In 1944, people started using the Bretton Woods system of international financial organization. In those days, you couldn’t just exchange one currency for another, as is the case now. For the exchange, you had to buy dollars by selling the currency that you had. If you had the desire to buy pounds and at the same time you only had francs, then you had to carry out two operations. The first is to buy dollars for francs and then buy pounds for dollars. It doesn’t sound very convenient nowadays.
At the same time, the price of the dollar was fixed and supported by gold. The dollar was worth a troy ounce, which is a little more than 30 grams of gold. All major currencies had established exchange rates against the dollar and their changes were possible only through the mechanisms of devaluation and revaluation.
In those times, the main world currency which was necessary to exchange one currency for another was the US dollar. But it turned out that placing such a huge responsibility on one currency has an excessive impact on the system and sooner or later leads to its collapse. So, there were more dollars needed to provide the necessary volume for the world currency exchange. That led to the situation when US authorities had to resort to emissions. The consequence was that the real ratio of the currency to the available gold became impossible to maintain on an official level. On paper, the dollar was still worth one troy ounce of gold, but in reality, the state could not provide it.
The Collapse of the Bretton Woods system
Since the dollar had to be backed by a certain amount of gold, it was possible to exchange dollars for gold at the official setup rate. In 1965, about one and a half billion dollars were accumulated in the National Bank of France, and then President Charles de Gaulle demanded that the President of the United States exchange this money for gold at the official rate. It turned out that this amount was equal to 16,500 tons of gold, which accounted for more than 70 percent of all gold that the US had. Thus, Charles de Gaulle wanted to challenge the system in which the US dollar was considered the main world currency. This whole situation led to the fact that in 1968 the United States was forced to limit the exchange of currency for gold, and there were two rates of gold against the dollar, official, and market ones.
And already in 1971, the history of the creation of the Forex market was started by a single person.
We can not say that he was the creator of the Forex market, but definitely had the greatest impact on its formation. This man is Richard Nixon. It all started with his decision to abolish the gold standard.
After that, the dollar devalued several times, and in 1973, the international Jamaica Conference took place, where all currencies switched to market regulation, and three years later, all countries switched to the Jamaica Accords.
Jamaica Accords
This system, which is used to this day, and its main difference from the previous system is the floating exchange rates, which are determined by the market situation.
With the advent of this system, three exchange rate regimes appeared: the first is the fixed exchange rate regime – this is the establishing official ratio of the national currency to the foreign currency by the state, which allows the exchange rate to fluctuate within a few percent. This system includes several mechanisms, such as dollarization which considers using of foreign currency in the country as a means of payment. Usually, this mechanism is used by small and dwarf states, and the currency of the nearest neighbors usually becomes their choice.
The second mechanism is the pegging of the exchange rate to another currency, usually one of the most significant world currencies.
And the third mechanism is the conventional fixed peg arrangement, which means the binding of the exchange rate to a group of currencies, such as a currency basket.
The forth is the dirty floating regime, in turn, it includes such mechanisms as the adjusted exchange rate regime – this is the linking of the exchange rate to a group of economic indicators. The second mechanism is a creeping fixation, in which there is a certain value of the exchange rate that the central bank tries to maintain through intervention in the market.
Other mechanisms of this regime are the pegged exchange rates within horizontal bands – in which the state tries to keep the exchange rate fluctuations within certain limits.
Other mechanisms of this regime are the pegged exchange rates within horizontal bands – in which the state tries to keep the exchange rate fluctuations within certain limits.
And there is also a currency regime with a floating rate, which is based on market regulation. Most developed countries use a floating exchange rate, and currencies with such a regulatory regime are the most traded.
Current Forex Trading
A new wave of technological development has affected all areas of life, including the financial markets. In 1984, the United States created NSFNET for communication between universities, and by 1992 year, more than 7,500 networks were connected to this network.
After the Internet became available to most, offline brokers were replaced by online Forex brokers, which affected the growth of the market, reducing trading spreads and increasing leverage. Now individual traders can trade in all corners of the world 24 hours a day with absolutely any currency.
Conclusion
This is the way how the Forex market turned from the regulated system of Bretton Woods into a free market where absolutely everyone can earn.
Have a good trade
