Way back when kings thought they possessed a divine right to rule, they often desired more money than their parliaments allowed them. But most parliamentary bodies knew certainly better than to entrust the powerful tool of taxation solely in the hands the king; they didn’t comprise of fools.
Because the king wasn’t able to tax to his heart’s content, his other financial weapon was devaluing his country’s currency: recalling all gold and silver coinage, melting it down, and then reissuing it with base metals mixed in or in a lighter weight hence filling up the royal treasury with the extra. The king in the end got his way because the currency was supported more by the citizens’ confidence in their country’s stability than with anything else, and many people never even noticed.
But at times people did notice, and weren’t totally confident in the stability of their country, say, if there was a threat that a powerful enemy was about to invade. When that happened, merchants often rejected the devalued coinage in trade and instead demanded real gold or silver thus leaving the king’s currency valueless. This undermining of the currency could result to a rapid disintegration of the king’s government.
In the 18th and 19th centuries, the western world’s increasingly republican governments began to base their currencies on gold instead of on confidence in the government. This banned their rulers from devaluing the currency, although, it also had some problems.
The gold standard led to a cycle of boom and bust: financially strong nations imported the goods its citizens wanted, which led to an outflow of capital till the money supplies diminished too far, and resulting to lower prices (as people no longer had enough money to buy anything) and higher interest rates. Then, other countries saw the low prices and started importing the first nation’s goods, resulting to an outflow of production and an inflow of money, thus flattening down interest rates and again raising the standard of living.
This boom-bust pattern persisted in many western countries until World War I, which interfered with trade and blocked the flow of money across borders. The pattern took up again after the war and throughout the Roaring Twenties, up until the US dollar devaluation caused a worldwide depression because of the stock market crash of 1929. It was only eased in the US by the World War II economic boom when the drafting of men into the military forces and the production of war materials cured the problems of high prices and unemployment.
But although the 2nd World War relieved the economic ills in the US, in other countries it caused them as they had to purchase the war materials they had no way of manufacturing themselves. This led to the Bretton Woods Accord, an agreement designed to create a stable post-war economy wherein the nations of the world could recuperate financially. It was signed in New Hampshire in year 1944.
The Bretton Woods Accord made itself the benchmark that measured all other currencies as it “pegged” the US dollar to the price of gold at $35 dollars per ounce and also pegged the value of the major world currencies to the US dollar. It also created the IMF (International Monetary Fund), a confederation of 185 nations around the world dedicated to nurturing economic stability and sustaining high employment.
The Bretton Woods Accord became very effective for decades but when the early 70s came, currency rates became extremely incontrollable as international trade activity went to an unstoppable boom. In 1973, finally, President Richard M. Nixon permitted the US dollar to be removed from the gold standard, and the complicated arrangement of currency values was finally abolished.
And just like in the olden days of kings, the market forces of supply and demand controlled the currencies WITHOUT being pegged to any precious metal or to any other currency. (Some of the world’s smaller nations preferred to peg their currency to that of a major trading partner – like some Caribbean nations to the USA.) This created the Forex market wherein one currency can be traded against another with the anticipation of earning profit from the currencies’ changes in their relative values. The major currencies of the world have now come full circle.
At first, only major central and commercial banks traded the Forex but later on large international corporations, mutual funds, hedge funds, and some ultra-wealthy individuals discovered it and Forex became widely known. By the 1980s decade, about $70 US billion dollars per day was changing hands.
The upsurge of the Internet and the increase in computer security systems brought Forex trading online. There was no longer any need to wait for business hours as trades were able to be placed independently of any bank. Traders began dealing around the globe across time zones.
In 2000, the Commodity Futures Modernization Act was passed by the US Congress and opened the Forex to the average investor. Retail brokerages surged across the Internet and today about $1.5 US trillion dollars is traded per day. Five percent of that amount is banks, travelers, and international corporations’ currency conversion and the remainder is trade for profit.