3. History of Forex

Before starting trading forex, every trader must understand some of the key events that happened in the past. These events are repeatedly mentioned by many professional foreign-exchange traders even today.


Bretton Woods

Dollar as the world’s key currency.


In July 1944, a new treaty was needed to control the international economy after World War II. Representatives from 44 countries gathered in Breton Woods, New Hampshire, the United States. Many agreed that instability in the global economy was one of the leading causes of the war and that the international community should prevent such instability in the future.

The treaty, drafted by renowned economists John Maynard Keynes and Harry Dexter White, was proposed to support Britain before and after the war as part of the United States’ Lend-Lease Act.

The Lend-Lease Act of the United States was enacted in March 1941 to provide supplies to the United Kingdom, the Soviet Union, France, and China, where the United States was allied. After several rounds of negotiations, the Bretton Woods Agreement was signed, with the following essential details:

1. To promote fair trade and harmonization of the international economy, an international organization shall be established.

2. Adopt a fixed exchange rate system between currencies.

3. Designate the U.S. dollar as the world’s key currency by allowing a convertible between gold and the U.S. dollar.

Only the first of the above three are valid to this day. Organisations formed as a direct result of Bretton Woods, including the International Monetary Fund, the World Bank, and the General Agreement on Tariffs and Trade (GATT), remain to this day to play an essential role in the development and regulation of the international economy. For example, with the Brenton Woods system’s implementation, the IMF fixed the gold at $35 per ounce and introduced a fixed exchange rate system based on a fixed exchange rate system between each currency.

Even after the Bretton Woods system’s end, the IMF worked closely with the World Bank (established under the Bretton Woods system). These two organisations regularly contribute funds to developing countries, helping developing countries develop their public infrastructure. They are now operating to support a sound commercial economy that can contribute to the international stage. The World Bank and the IMF are also working closely with GATT to ensure these developing countries’ opportunities to trade equally and fairly with their industrialised counterparts.

GATT was initially established as a temporary organisation but is now operating to encourage the dismantling of trade barriers such as tariffs and quotas. The Bretton Woods Agreement took effect from 1944 to 1971, but to secure the Bretton Woods system’s flaws, President Nixon proposed the Smithsonian Agreement.

However, the Smithsonian Agreement had the same critical weakness as the Bretton Woods Agreement. It had maintained a fixed exchange rate system without acknowledging the gold against the U.S. dollar. This fixed exchange rate system failed to accommodate international demands for a sustained U.S. trade deficit and a weak dollar. As a result, the Smithsonian Agreement did not last long.

Ultimately, the exchange rate system evolved into a free-floating exchange rate market where demand and supply determined its value. However, this has led to several currency crises and increased volatility between currencies. As a result, the market is automatically controlled, and the appropriate value of the currency is formed in the market without any special restrictions.

The Bretton Woods has significantly contributed to changing the U.S. dollar’s perceptions on the international economical stage. While the British Pound is still showing considerable strength and the Euro is under the new spotlight for international trade as an innovative currency, the dollar has been chosen as the world’s key currency for the time being. This can be attributed mainly to the Brenton Woods Agreement, which guaranteed its credibility and accessibility based on the dollar to gold transition system. The Bretton Woods system is a policy of the past, but the impact on the U.S. dollar and the international economy remains significant to this day.




The End of Bretton Woods

The Birth of Free Market Capitalism



On August 15, 1971, the Brenton Woods system officially ceased to fix the currency’s value to gold prices. A new form of system emerged for a while before the Brenton Woods system disappeared, but the Brenton Woods system officially came to an end. The value of currencies is fixed at the price of gold, and the structure of a limited exchange rate fluctuation in the range of only one per cent disappears. Instead, the fair value of currency1 is determined by free-market economic behaviour such as trade and direct foreign investment.

U.S. President Nixon was confident that the end of the Bretton Woods system would bring a better new era for the international economy. However, he was not a free market believer who believed that the market could value the currency legally and freely. Like most economists, President Nixon also determined that a completely unorganised foreign exchange market would lead to a competitive devaluation, an obstacle to international trade and investment. The outcome predicted by President Nixon and his economic advisory committee was a global economic slowdown.

A few months later, the committee signed the Smithsonian Agreement. The Smithsonian Convention, praised by President Nixon as the “Greatest monetary agreement in the world’s history”, sought to maintain a fixed exchange rate system without gold. The Bretton Woods system’s key difference is that the dollar’s value can fluctuate within the range of 2.25% (which allows only within 1% of the Brenton Woods system).

Eventually, the Smithsonian Agreement turned out to be an intricate system to implement. Gold prices surged to $215 an ounce in the free market, as the exchange rate did not fix gold prices. Moreover, the U.S. trade deficit continued to grow, and from a fundamentals perspective, the U.S. dollar needed to depreciate its currency beyond the 2.25% limit set out in the Smithsonian. Due to the exposure of these problems, the foreign exchange market was forcibly closed in February 1972.

The foreign exchange market reopened in March 1973, and the Smithsonian Agreement was no longer valid. Since then, the U.S. dollar has not been fixed by any commodity and changes in the exchange rate are not limited to a specific limit, so the U.S. dollar exchange rate has been determined entirely in the market. This naturally provided the U.S. dollar and other currencies with the agility to adapt to a new and rapidly evolving international trade environment. However, it also served as a springboard for unprecedented infrastructure. Crude oil prices soared as conflicts grew in the Middle East. The Brenton Woods and Smithsonian Agreement created stagflation represented by unemployment and inflation in the United States.

The stagflation lasted until the early 1980s, when Federal Reserve Governor Paul Volker initiated new economic policies. President Ronald Reagan introduced a new financial plan to help the U.S. dollar return to an average value. Fortunately, the foreign exchange market has made significant progress and achieved various goals. As the U.S. eased regulations for free international trade, investors who wanted to participate in the market showing abundant liquidity and continuous growth flowed into the foreign exchange market. Consequently, the end of the Bretton Woods system in 1971 marked the beginning of a new economic era, represented by international tradings’ liberalisation and the surge in speculative capital influx.



Plaza Accord

Devaluation of the U.S. dollar (1985)



After the end of the 20th century, the currency market remained completely unregulated except for the ‘invisible hand’ that sought an economic balance by the demand and supply of free-market capitalism, unfortunately, due to unforeseen economic events (OPEC oil crisis, stagflation in the 1970s), supply and demand have become inefficient means to control the currency market on their own.

It has already been proven that pegging currency values to commodities such as gold, or setting maximum exchange rate fluctuations, is too inflexible to entice economic development. A balance between the system and strict rules has plagued the currency market for the 20th century, and the countries still needed a final solution while progress was being made.

Therefore, in 1985, finance ministers and central bank governors of the world’s largest economies (France, Germany, Japan, United Kingdom, and the United States) held a meeting in New York in the hope of reaching a diplomatic agreement to maximise the economic efficiency of the foreign exchange market.

In a rare meeting at the Plaza Hotel, international leaders reached an absolute consensus on a particular country and the entire global economy. Inflation was at a shallow level throughout the world. Stagflation in the 1970s was represented by high inflation and low growth, but in contrast, in 1985, the global economy showed low inflation and high growth, moving in a 180-degree turnaround.

Despite substantial economic growth, low inflation continued to lead to low-interest rates favouring developing countries, but risks of protectionist policies such as tariff barriers were becoming visible. Japan and Germany had substantial current account surpluses, while the U.S. had a growing current account deficit. Realistically, this fundamental imbalance could cause severe economic imbalances, leading to a distortion of the foreign exchange market and the international economy.

With the current account imbalance and the resulting protectionist policies emerging, countermeasures were required. Eventually, these led to the conviction that the value of the U.S. dollar was rising more than 80 per cent faster than significant trading partner currencies. As the value of the U.S. dollar rose, the U.S. showed a considerable trade deficit. On the contrary, the depreciation of the U.S. dollar automatically brought about a balance between exports and imports of all other countries, helping to stabilize the international economy more efficiently.

At the Plaza Hotel conference, the United States persuaded other participants to coordinate multilateral intervention, and the Plaza Accord was reached on September 22, 1985. The agreement was designed to allow the depreciation of the dollar and the appreciation of significant counter-currency.

Countries have agreed to intervene in the currency market to revise their economic policies and induce the dollar to depreciate. The U.S. agreed to reduce its budget deficit and cut interest rates, while France, Britain, Germany and Japan agreed to raise interest rates. Germany also agreed to implement the tax cut, while Japan decided that the yen’s value would fully reflect the Japanese economy’s fundamental strength.

But the real problem with the actual implementation of the Plaza Accords is that not all countries stuck to their promises. In particular, the U.S. did not fulfil its initial commitment to reduce the budget deficit. Japan has been hit hard by the yen’s rapid appreciation. Japanese exporters have lost competitiveness in overseas markets, which eventually led to a decade of economic stagnation in Japan. On the contrary, the United States achieved significant economic growth and price stability due to the Plaza Accord.

The multilateral intervention effect was immediate, and within two years, the dollar fell 46 per cent against the German DEM and 50 per cent against the Japanese YEN. As a result, the U.S. economy has become much more export-driven, while industrial countries such as Germany and Japan have become importing countries. This phenomenon gradually resolved the current account deficit problem, and the international community minimised protectionist policies to the extent that they did not pose a risk to the global economy.

But most importantly, the Plaza Accord has shown the significance of central banks’ role to control exchange rate movements. Since the exchange rate was not fixed, the exchange rate was primarily determined by supply and demand in the market. However, these invisible hands by demand and supply alone were insufficient. The central banks worldwide are responsible for intervening in the foreign exchange market on behalf of the international economy.



George Soros

The man who surrendered the Bank of England.



When George Soros won a $10 billion speculative bet against the British pound, he was known by everyone as the “Man who brought down the Bank of England.” Whether people like or dislike George Soros, he is involved in one of the most exciting events in the history of currency transactions.


1. Britain Applied Exchange Rate Adjustment Mechanism


In 1979, the European Monetary System was established, led by France and Germany, to stabilise exchange rates, curb inflation, and prepare for currency integration. One of the critical elements of the European monetary system, the exchange rate adjustment mechanism, established a benchmark exchange rate against the European monetary unit, a basket of currencies for participating countries.

The system kept the participating countries’ exchange rates within the range of 2.25% up and down each benchmark exchange rate. The ERM was a fixed, adjustable exchange rate system, and nine reporting of the benchmark exchange rate were made between 1979 and 1987. The UK was not the first to join the ERM in 1990, with a pound-to-German mark benchmark exchange rate of 2.95 and a +/- 6 per cent fluctuation.

Until mid-1992, the ERM appeared to be successful, with diminished inflation in Europe due to the German Central Bank’s leadership’s regulatory effect. However, the initial stability did not last long as international investors began to feel the value of some currencies in the ERM was inadequate.

When Germany was unified in 1989, government spending increased, and the central bank had to print more money. This boosted inflation and left the German central bank unable to do anything but raise interest rates. Germany’s interest rate hike has further affected ERM by putting upward pressure on the German mark’s value.

Consequently, to maintain a fixed exchange rate within the ERM, Irving Fisher’s interest rate equilibrium theory led other central banks to raise their interest rates. It was at this time that George Soros began to take action. Considering Britain’s weak economy and high unemployment, he judged that the British government would not maintain a fixed exchange rate policy.


2. Soros bet on Britain’s failure to join ERM.


Soros, a Quantum hedge fund manager, thought the UK had no choice but to devalue the pound or withdraw from ERM and determined to bet on the pound’s depreciation. During the ERM period, capital regulations were continuously removed, making it easier for international investors to recognise imbalances, and they were able to make these imbalances an opportunity.

Soros built a short position against the pound and an extended position against the mark by borrowing the pound and investing in the Mark-marked assets. Soros also utilised huge options and futures contracts. His positions totalled $10 billion. Soros was not alone, of course. Many investors soon followed him. Everyone sold the pound, which acted as a substantial downward pressure on the pound.

Initially, the Bank of England attempted to defend the fixed exchange rate by buying an enormous reserve asset of £15 billion. However, their involvement in the foreign exchange market was not enough. Market participants traded the pound very close to the bottom of the fixed exchange rate fluctuation range.

On September 16, 1992, the day it was later called Black Wednesday, the central bank announced a 2 per cent increase in interest rates (10 per cent to 12 per cent) to support the pound. A few hours later, he promised to raise interest rates by an additional 15 per cent. Still, Soros and other international investors remained unmoved when they learned that the opportunity to realise huge profits was close. Traders continued to sell the pound on a large scale, but the Bank of England continued to buy the pound.

At 7 p.m. on the same day, when Treasury Secretary Norman Lamont declared, “The U.K. is leaving the ERM.”, and interest rates returned to the first level of 10 per cent. Chaotic Black Wednesday was a prelude to the pound’s steep depreciation.

Whether the transition to a floating exchange rate was due to Soros’s attack on the pound, or just fundamentals, remains a subject of debate today. However, what is certain is that over the next five weeks, the pound has fallen about 15 per cent against the German mark and has lost 25 per cent against the dollar, giving Soros and other traders huge profits.

Within a month, Quantum Fund earned about $2 billion by selling more expensive German Marks and purchasing cheaper pounds. The case of “The man who brought the Bank of England to its knees” was a representative case of how vulnerable the central bank is too speculative attacks.



1997-1998 Asian Financial Crisis


1. The Emerging Economies


Asian Tiger economies collapsed on July 2, 1997. It is a perfect example of the global capital market’s interdependence and the subsequent impact on the currency market. Although several fundamental collapses triggered the crisis, the primary reason stemmed mainly from opaque lending practices, rising trade deficits and immature capital markets.

The combination of such factors made major regional markets incompetent, creating a catastrophic situation that brought highly valued currencies down to a significantly lower level. During this period, the crisis badly influenced the stock and the currency market.


2. Bubble


By 1997, the increment of asset prices increasingly attracted investors to the prospects of Asian investment focused on real estate development and the stock market. As a result, foreign investment capital has flowed into areas where economic growth is rising due to increased production, such as Malaysia, the Philippines, Indonesia, and Korea.

Thailand saw economic growth of 13% in 1988, which fell to 6.5% in 1996. Thailand implemented a fixed exchange rate system to peg the baht to a reliable U.S. dollar to provide additional loan support for a healthy economy. By pegging the exchange rate to the U.S. dollar, countries like Thailand sought financial stability in their markets and guaranteed a fixed exchange rate for export deals with the U.S. 


3. Expansion of Current Account Deficit and Loans


However, in early 1997, the sentiment for such fundamentals began to change. Each government found it increasingly difficult to handle the current account deficit, and its lending practices affected the economic structure negatively. In particular, economists were nervous that Thailand’s current account deficit increased to $14.7 billion in 1996.

Although it was relatively smaller than the U.S. current account deficit, Thailand’s deficit gap stood at 8 per cent of GDP. Opaque lending practices have also contributed significantly to this collapse. Senior bank officials and individually close borrowers were given preferential treatment for loans, which, surprisingly, became standard throughout the region. This practice has affected many large Korean companies that rely heavily on debt, with the total amount of bad loans soaring to 7.5 per cent of GDP.

Additional examples of this practice are seen in Japanese financial institutions. In 1994, Japanese authorities announced $136 billion in loans, but a year later revised $400 billion. In addition to the sluggish stock market, the decline of real estate values and the slowing economy allowed investors to expect the Japanese yen to fall, increasing selling pressure on neighbouring currencies.

When Japan’s asset bubble collapsed, asset prices fell the same value as two years’ worth of national production, and property prices accounted for nearly 65 per cent of the total decline.

The drop in asset prices sparked a banking crisis in Japan. The banking crisis began in the early 1990s and spread to the overall system crisis in 1997, leading to several high-profile financial institutions’ bankruptcy. In response, the Japanese currency authorities mentioned a potential increase in the benchmark interest rate to defend its currency value. Unfortunately, Japan\ did not implement these ideas at all, and only a few were empty.

The fall in the exchange rate was snowballing as the central bank’s reserves dried up. The currency’s value was challenging to maintain, considering the downward pressure by currency, based on the announcement of Thailand’s implementation of the floating exchange rate system.


4. A Currency Crisis


After large-scale short speculation and market intervention, the aforementioned Asian countries suffered disasters and fell into incompetence. Thailand’s baht, once recognised as an investment asset, fell 48 per cent in value. The most affected currency was Indonesia’s Rupia.

Rupia, which had usually been relatively stable with Thai baht before introducing the adjustment exchange rate system, suffered a whopping 28 per cent drop from 12,950 when it was pegged to the U.S. dollar. Among the major currencies, the Japanese yen fell about 23 per cent from a high to a low against the U.S. dollar during 1997 and 1998. The 1997-98 financial crisis shows the interconnection between countries and how it affects the global market. These are examples of how difficult it is for the central bank to successfully intervene when facing enormous market pressure without guaranteeing improvements in economic fundamentals.

Today, Asia’s four small dragons are wiggling thanks to IMF restructuring package support and better implementation of stricter requirements again. Setting inflation standards and rejuvenating export markets, Southeast Asia builds its previously major industrialised economies worldwide.

After experiencing depletion of foreign exchange reserves, the Asian Tigers focus on keeping enough foreign currency reserves to defend speculators’ to attack their currencies again.



Launch of the Euro (1999)



The launch of the euro was a monumental event as the most extensive currency conversion ever made. The euro was officially launched on 1 January 1999 as a currency traded only on computer books without any real issues. Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland were the first of the 11 members of the European Monetary Union. Greece became the first countries to use the euro two years later.

Countries pegged their currencies at a specific conversion rate to the euro and adopted a standard currency policy controlled by the European Central Bank. For many economists, the system was ideal for including all 15 European Union countries, but Britain, Sweden and Denmark decided to keep their currencies for the time being.

Euro notes and coins were not in circulation until the first two months of 2002. Officially, the euro notes and coins were introduced from 1 January 2002 to 28 February 2002, after a two-month exchange period, the EU thoroughly used the euro from 1 March 2002. On 1 January 2014, Latvia participated in the euro, expanding the number of countries currently using the euro as their official currency to 18 countries. All EU member states had to weigh the gains and losses in deciding whether to settle the euro.

For EMU citizens, travel convenience may be the most prominent problem, but the euro has also brought many other benefits.

1. The euro provided a more stable environment for trade in Europe by eliminating exchange rate fluctuations between countries in use.

2. Eliminating all exchange rate risk within the eurozone allows companies to plan investment decisions very accurately.

3. Transaction costs have been reduced. Transaction costs refer to the costs associated with foreign exchange management, hedge management, cross-border payments and the operation of multiple currency accounts.

4. Consumers and businesses can more easily compare prices of goods between countries, making them more transparent and competitive.

5. The huge single currency market has become more attractive to foreign investors.

6. The economy and stability of a huge scale boosted confidence, which allowed the European Central Bank to control prices at low-interest rates.

However, the euro also has its limitations. Even if putting political issues aside, the biggest problem is countries that adopt the euro cannot have any independent monetary policy. Because each country’s economy does not have a perfect correlation with the EMU’s, some countries may face a situation where the European Central Bank raises interest rates during the recession.

This happened in many small countries. As a result, governments try to rely more heavily on fiscal policy. Still, the effective fiscal policy’s effectiveness limited if it is not effectively combined with monetary policy. This inefficiency was exacerbated by the EMU’s regulations restrict the budget deficit to 3% of GDP as specified in its Stability and Growth Convention.

There are also some concerns about the validity of the European Central Bank. ECB set inflation target slightly below 2%, but from 2000 to 2002, eurozone’s inflation was slightly above the benchmark and exceeded the target level. By the end of 1999, due to the European Union’s lack of a new currency, the euro’s U.S. dollar exchange rate fell 24% in January 1999 from 1.15 to 0.88.