Forex trading has been going on longer than you may think. Officially forex trading goes back a few hundred years but in many ways it dates back even further.
Currencies have formed an essential part of human societies for a long time, but it is only with trading between nations that the exchange between different currencies became possible – and necessary.
Understanding how the trading of currencies evolved can help guide our thinking on the wider role of forex trading in the global economy and why it is such a substantial market today.
The Origins of Currency
The earliest form of human exchange is widely thought to date back to the Babylonians in around 6000 BC. This was a system of barter that involved people trading items for other goods. The most popular goods, like spices and salt then become common means of exchange and were even used abroad as a standard means of barter.
The next step forward came in the Kingdom of Lydia in around the seventh century BC, with the introduction of gold as a means of exchange. The Ancient Romans and Greeks followed suit and began using gold coins and other metals such as silver as forms of currency.
Gold became the foremost type of currency mainly because of its desirability but also how stable, solid and reliable it was. The Romans also used bronze bars as a form of payment for fines and taxes.
Gold, silver and bronze coins were used for hundreds of years in the Ancient world with their value being based on their weight. The Romans later introduced a centralized system of currency which they had a monopoly over, issuing currency based on standardized coins.
Ancient coins which formed some of the first standardized currencies in the world
This created stability in the Roman Empire’s economy for a long period of time, but it could not stop their currency eventually suffering from inflation in later centuries, as the Romans devalued their currency by issuing diluted forms of coins in an effort to pay for an over-extended empire that needed defending.
In the end runaway inflation of the Roman currency is one of the factors historians attribute to the collapse of the Roman Empire in the fifth century AD.
The Age of Copper – And Paper
Whilst for the remainder of the bronze age gold and silver remained the dominant form of coinage, it was later replaced by copper in the middle ages, which was cheaper and easier to produce.
Banks started to spring up around one thousand years ago and some of the earliest banks were there to enable currency transactions.
The introduction of paper currency is generally thought of as a European invention but it actually dates back to the Tang Dynasty in China in the seventh to tenth centuries AD. Having to transport large quantities of heavy coins was inconvenient for merchants, so written notes were used instead. These served as a form of credit which the holder could claim in hard currency at a later date if they wished. Hence you can still see inscriptions like “I promise to pay the bearer of…” and such like on bank notes today.
Following travel and trade to China by those such as Marco Polo, paper notes as a form of currency were introduced to Europe in around the eleventh century and became popular thereafter.
The World’s First Forex Exchange
As paper became more popular as a form of currency across Europe in the following centuries, so it became more convenient for merchants to exchange paper notes of different currencies. Eventually it became sensible to set up a formal exchange to do so, and the first one was opened in Amsterdam in the 1600s.
Amsterdam then became a real hub for traders and with a central foreign exchange bureau, there were finally some formal rates of exchange set for currencies against each other.
Merchants could take currencies they had been paid in and exchange them for other currencies – in many cases the currency of their own land but sometimes currencies of other territories they intended to do business in later.
Some traders just bought and sold currencies to speculate on them increasing or decreasing in value against other currencies – starting the formal industry of foreign exchange trading that continues to this day.
The Gold Standard
Whilst there were many advantages to a paper-based system of currency, clearly there were also downsides – one of which was inflation. In order to tackle this, the gold standard was introduced in 1875. This meant that countries could only issue as much paper currency as they had equivalent value of in gold reserves. This provided stability and trust to the global currency system.
However, with the advent of the First and Second World Wars, countries were spending far more money than they held in gold reserves. The system could not be sustained. So in 1944 the Bretton Woods Agreement was signed, which made the US dollar the reserve currency alongside gold.
The dollar became the world’s reserve currency alongside gold in 1944
The US was happy with this because it boosted the dollar’s reputation, which had suffered considerably from the Wall Street Crash and Great Depression in preceding decades. Other countries were also content with this agreement because they could exchange their currencies for the dollar, which was much easier and cheaper for them than gold.
An unintended consequence however was that investors preferred putting their money in areas where currencies were weaker and therefore favored Europe. So the US ended the Bretton Woods Agreement in 1973 and the gold standard was no longer used. Economists argue over whether this has been a good thing by allowing higher government spending on infrastructure, education, healthcare and the like or has been detrimental by opening up the possibility of runaway inflation as governments can effectively keep on printing money endlessly.
The Computer Age and Modern Forex Trading
Not long after the end of the Bretton Woods Agreement came of course the beginning of the computer age and everything that followed – digitization, the internet, globalization and instant foreign exchange trading. Today we live in a world where billions of dollars of currency are exchanged every day.
Now you can exchange currencies from all over the world at the touch of a button from the comfort of your own bedroom. You can speculate on currencies going up or down and use increasingly sophisticated tools to monitor and try to predict the markets.
There are even forex robots that can trade for you so you don’t need to do anything. Things have certainly come a long way from the days of people bartering for goods back in Babylonia!