A Brief History of Currency Trading

Ancient Times

Foreign exchange dealing can be traced back to the early stages of history, possibly beginning with the introduction of coinage by the ancient Egyptians, and the use of paper notes by the Babylonians. Certainly by biblical times, the Middle East saw a rudimentary international monetary system when the Roman gold coin aureus gained worldwide acceptance followed by the silver denarius, both a common stock among the money changers of the period.
In the Bible, Jesus becomes angry at the money changers. I hope His wrath was directed at the poor exchange rates and not the profession itself!

Into the Middle Ages, foreign exchange became a function of international banking with the growth in the use of bills of exchange by the merchant princes and international debt papers by the budding European powers in the course of their underwriting the period's wars. By the end of the Renaissance, money and currency trading were the lifeblood of most civilized nations. In the eighteenth century, banker Mayer Rothschild said, "Give me control over a nation's money and I care not who makes her laws."

The Gold Standard, 1816 to 1933

The gold standard was a fixed commodity standard: Participating countries fixed a physical weight of gold for the currency in circulation, making it directly redeemable in the form of the precious metal. In 1816, for example, the pound sterling was defined as 123.27 grains of gold, which was on its way to becoming the foremost reserve currency and was at the time the principal component of the international capital market. This led to the expression "as good as gold" when applied to Sterling—the Bank of England at the time gained stability and prestige as the premier monetary authority.

Of the major currencies, the U.S. Dollar adopted the gold standard late in 1879 and became the standard-bearer, replacing the British Pound when Britain and other European countries came off the system with the outbreak of World War I in 1914. Eventually, though, the worsening international Depression led even the dollar off the gold standard by 1933; this marked the period of collapse in international trade and financial flows before World War II.

The Federal Reserve

As an investor, it is essential to acquire a basic knowledge of the Federal Reserve System (the Fed). The Federal Reserve was created by the U.S. Congress in 1913. Before that, the U.S. government lacked any formal organization for studying and implementing monetary policy. Markets were consequently often unstable and the public had little faith in the banking system. The Fed is an independent entity, but is subject to oversight from Congress. This means that decisions do not have to be ratified by the president or anyone else in the government, but Congress periodically reviews the Fed's activities.

The Fed is headed by a government agency in Washington known as the Board of Governors of the Federal Reserve. The Board of Governors consists of seven presidential appointees, each of whom serve 14-year terms. All members must be confirmed by the Senate, and they can be reappointed. The board is led by a chairman and a vice chairman, each appointed by the president and approved by the Senate for four-year terms. The current chair is Ben Bernanke, who was sworn in on February 1, 2006, and whose term as chairman expires in 2014.

There are 12 regional Federal Reserve Banks located in major cities around the country that operate under the supervision of the Board of Governors. Reserve Banks act as the operating arm of the central bank and do most of the work of the Fed. The banks generate their own income from four main sources:
  1. Services provided to banks.
  2. Interest earned on government securities.
  3. Income from foreign currency held.
  4. Interest on loans to depository institutions

The income generated from these activities is used to finance day-to-day operations, including information gathering and economic research. Any excess income is funneled back into the U.S. Treasury.

The system also includes the Federal Open Market Committee, better known as the FOMC. This is the policy-creating branch of the Federal Reserve. Traditionally, the chair of the board is also selected as the chair of the FOMC. The voting members of the FOMC are the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Reserve Banks who serve on a one-year rotating basis. All Reserve Bank presidents participate in FOMC policy discussions whether or not they are voting members. The FOMC makes the important decisions on interest rates and other monetary policies. This is the reason they get most of the attention in the news media.

The primary responsibility of the Fed is "to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar, and moderate long-term interest rates."

In other words, the Fed's job is to foster a sound banking system and a healthy economy. To accomplish its mission, the Fed serves as the banker's bank, the government's bank, the regulator of financial institutions, and as the nation's money manager.

The Fed also issues all coin and paper currency. The U.S. Treasury actually produces the cash, but the Fed Bank then distributes it to financial institutions. It is also the Fed's responsibility to check bills for wear and tear, taking damaged currency out of circulation.

The Federal Reserve Board (FRB) has regulation and supervision responsibilities over banks. This includes monitoring banks that are members of the system, international banking facilities in the United States, foreign activities of member banks, and the U.S. activities of foreign-owned banks. The Fed also helps to ensure that banks act in the public's interest by helping in the development of federal laws governing consumer credit. Examples are the Truth in Lending Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, and the Truth in Savings Act. In short, the Fed is like a police officer for banking activities within the United States and abroad.

The FRB also sets margin requirements for stock investors. This limits the amount of money you can borrow to purchase securities. Currently, the requirement is set at 50 percent, meaning that with $500 you have the opportunity to purchase up to $1,000 worth of securities.

Most people accept the Fed without question, even though very few understand even its most basic operations. Auto magnate Henry Ford once said, "If the public knew what the Federal Reserve did, there would be a revolution before the sun comes up tomorrow."

Many of those who do know have concluded the economy would be better off without it. Let the market decide the ratio between spending and savings, they say. The Fed ultimately acts to redistribute wealth by increasing the money supply and lending it cheaply to banks, which, in turn, lend it back to the people who created the wealth in the first place. In essence, a bank may get money at 2 percent that some see as a 29 percent rate on their credit card. Critics say the Federal Reserve System is neither federal, a reserve, nor a system.

Securities and Exchange Commission, 1933 to 1934

When the stock market crashed in October 1929, countless investors lost their fortunes. Banks also lost great sums of money in the Crash because they had invested heavily in the markets. When people feared their banks might not be able to pay back the money that depositors had in their accounts, a run on the banking system caused many bank failures.

With the Crash and ensuing depression, public confidence in the markets plummeted. There was a consensus that for the economy to recover, the public's faith in the capital markets needed to be restored. Congress held hearings to identify the problems and search for solutions.

Based on the findings in these hearings, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws were designed to restore investor confidence in capital markets by providing more structure and government oversight. The main purposes of these laws can be reduced to two commonsense notions:
  1. Companies that publicly offer securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.
  2. People who sell and trade securities—brokers, dealers, and exchanges—must treat investors fairly and honestly, putting investors' interests first.

The Bretton Woods System, 1944 to 1973

The post–World War II period saw Great Britain's economy in ruins, its infrastructure having been bombed. The country's confidence with its currency was at a low. By contrast, the United States, thanks to its physical isolation, was left relatively unscathed by the war. Its industrial might was ready to be turned to civilian purposes. This then has led to the dollar's rise to prominence, becoming the reserve currency of choice and staple to the international financial markets.

Bretton Woods came about in July 1944 when 45 countries attended, at the behest of the United States, a conference to formulate a new international financial framework. This framework was designed to ensure prosperity in the postwar period and prevent the recurrence of the 1930s global depression. Named after a resort hotel in New Hampshire, the Bretton Woods system formalized the role of the U.S. dollar as the new global reserve currency, with its value fixed into gold. The United States assumed the responsibility of ensuring convertibility while other currencies were pegged to the dollar.

Among the key features of the new framework were:

The End of Bretton Woods and the Advent of Floating Exchange Rates

After close to three decades of running the international financial system, Bretton Woods finally went the way of many historical arrangements that fall out of date, this one due to growing structural imbalances among the economies, leading to mounting volatility and speculation in a one-year period from June 1972 to June 1973. At that time, the United Kingdom, facing deficit problems, initially floated the Sterling. Then it was devaluated further in February of 1973, losing 11 percent of its value along with the Swiss Franc and the Japanese Yen. This eventually led to the European Economic Community floating their currencies as well.

Also historically significant was President Nixon's official abandonment of the gold standard in the United States in 1971.

At the core of Bretton Woods' problems were deteriorating confidence in the dollar's ability to maintain full convertibility and the unwillingness of surplus countries to revalue for its adverse impact on external trade. Despite a last-ditch effort by the Group of Ten finance ministers through the Smithsonian Agreement in December 1971, the international financial system from 1973 onward saw market-driven floating exchange rates taking hold. Several times, efforts for reestablishing controlled systems were undertaken with varying levels of success. The best known of these was Europe's Exchange Rate Mechanism of the 1990s, which eventually led to the European Monetary Union.

International Monetary Market

In December 1972, the International Monetary Market (IMM) was incorporated as a division of the Chicago Mercantile Exchange (CME) that specialized in currency futures, interest-rate futures, and stock index futures, as well as futures options.

Into the Millennium

Until the arrival of the Euro in 2002, the international scene had remained essentially unchanged for more than 30 years, even though the volume of transactions in foreign exchange has increased enormously. Electronic trading has made it possible to initiate instantaneous trades in the billions of dollars. This has introduced the fragile nature of technology, with its lack of redundancy, but no fallout from that has yet to be seen.

China's emergence as a world power has focused attention on its economy and its currency, the Yuan. It is at present controlled and does not float, although its official value is often adjusted. The author believes it will be impossible to continue the tight control over the Yuan, and floating rates will be inevitable. The chronically undervalued currency is having substantial repercussions for other countries and currencies and the cumulative effect may be yet another crisis in the making.

Arrival of the Euro

On January 1, 2002, the Euro became the official currency of 12 European nations that agreed to remove their previous currencies from circulation by February 28, 2002. See Table below.

Original European Monetary Union


The Euro was initially considered a great success, although in hindsight, countries were brought in to it too quickly. The Euro is now the second-most-frequently traded currency in FOREX markets behind the USD. Not coincidently, the EUR/USD is the most traded currency pair, although another, the GBP/JPY is the most volatile.

These countries are members of the Eurozone: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain. The Euro is also used in Montenegro, Andorra, Monaco, San Marino, and Vatican City.

The Euro has been in an on-and-off crisis for almost two years. Several financially weaker members periodically threaten to bring it down. Greece, Italy, Spain, and Portugal have all rotated in the debt crisis spotlight. Stronger countries, such as Germany, are balking from continued rescues by lending money to these weak sisters to keep them from national bankruptcy. Mutualizing the debt and issuing Eurobonds has been proffered, as have other ideas, such as encouraging Switzerland to join the Eurozone (European Union members who use the Euro) and sign on to it. Unfortunately, the debt of some countries is so massive that a simple solution is probably not possible. The more countries such as Greece tighten their belts to pay existing debt, the worse their economies become—in turn making further payments in the long term all but impossible. Once high-flying, the actual future of the Euro is in some doubt today. The contrary opinion is that—as opposed to the United States—the European countries are at least seriously addressing their debt.

The CFTC and the NFA

The new kids on the FOREX block for U.S. traders are the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). Previously dedicated to regulating the commodity futures industry, these agencies are becoming quickly and deeply (many say too deeply) involved in regulating the retail FOREX business. In 2009, NFA Compliance Regulation 2-43 went into effect and has made a profound impact on retail FOREX. The most recent regulations have lowered the maximum leverage for U.S. traders to 50:1 for major pairs and 10:1 for exotic pairs.

Table below depicts the major events in FOREX history and regulation.

Timeline of Foreign Exchange

1913 -- U.S. Congress creates the Federal Reserve System.
1933 -- Congress passes the Securities Act of 1933 to counter the effects of the Great Crash of 1929.
1934 -- The Securities Exchange Act of 1934 creates the beginnings of the Securities and Exchange Commission.
1936 -- The Commodity Exchange Act is enacted in direct response to manipulating grain and futures markets.
1944 -- The Bretton Woods Accord is established to help stabilize the global economy after World War II.
1971 -- The Smithsonian Agreement is established to allow for a greater fluctuation band for currencies. The United States officially abandons the gold standard.
1972 -- The European Joint Float is established as the European community tries to move away from its dependency on the U.S. Dollar.
1972 -- The International Monetary Market is created as a division of the Chicago Mercantile Exchange.
1973 -- The Smithsonian Agreement and European Joint Float fail, signifying the official switch to a free-floating system.
1974 -- Congress creates the Commodity Futures Trading Commission to regulate the futures and options markets.
1978 -- The European Monetary System is introduced to again try to gain independence from the U.S. Dollar.
1978 -- The free-floating system is officially mandated by the International Monetary Fund.
1993 -- The European Monetary System fails to make way for a worldwide, free-floating system.
1994 -- Online currency trading makes its debut.
2000 -- Commodity Modernization Act establishes new regulations for securities derivatives, including currencies in futures or forwards form.
2002 -- The Euro becomes the official currency of 12 European nations on January 1.
2009 -- The CFTC and NFA implement NFA Compliance Rule 2-43.
2010 -- The NFA sets minimum margin/maximum leverage for retail FOREX trading.
2011 -- The NFA sets maximum leverage for currency pairs.


Until the late 1960s, the currency markets were extremely stable and very much a closed club. Things were about to change rapidly! Currency trading is probably the world's second-oldest profession!

The Euro, introduced in 2002, is now the official currency of 22 European countries: Andorra, Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Kosovo, Luxembourg, Malta, Monaco, Montenegro, the Netherlands, Portugal, San Marino, Slovakia, Slovenia, Spain, and Vatican City.

NFA Compliance Rule 2-43 has in many ways changed how the game is played at the retail level, as has the lowering of leverage maximums for currency trading to U.S. traders. In a 2010 "gotcha" moment, margins were dramatically increased for U.S. FOREX traders. The Dodd-Frank legislation has ongoing and still not fully interpreted repercussions for retail FOREX. In 2011, spot trading in gold and silver on FOREX platforms was prohibited.

Some key dates—1973, 1978, 1994, 2002, 2009, 2010, 2011.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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