A Brief History of Currency Based Trading

The forex market currently makes up the largest financial market in the world, with a daily turnover of over US$2 trillion per day in a wide variety of actively traded currency pairs. Nevertheless, today's huge forex market has its origins in the days of the barter system, when the trading of goods was how people participated in commerce.

The following sections cover some of the early history of the currency market. This includes the transition from commercial transactions involving currency of intrinsic value like gold to the more modern prevalence of paper fiat currency that is simply backed by the credit of the country printing it.

The Forex Market's Ancient Roots

As commerce between different countries increased in early human civilized history, a standardized medium of exchange was needed to facilitate commercial transactions. The first generally-accepted medium of exchange consisted of the precious metals gold and silver. This practice gave rise to the minting of coins during the Roman era, which in turn evolved into the issuing of paper currency in the Middle Ages.

Paper money was originally introduced as a way to represent the value of gold for security purposes. Gold would first be deposited into a trusted bank, and a receipt would then be issued for the amount of gold on deposit that could be used as a medium of exchange in place of gold.

These receipts eventually evolved into becoming the principal instruments of exchange, and so governments began to issue currency backed by the country's gold reserves. This was later to become the first international monetary standard, known as the Gold Standard.

The Gold Standard

The origins of the Gold Standard in international commerce begin in 19^th century Britain after the English Monarchy adopted the Gold Standard in 1816 with the passage of the Coinage Act.

The Coinage Act was the first instance of defining the value of the British Pound Sterling in relation to gold. The value of one pound of 22-Karat gold at the time was set to be equivalent to £46 14 s 6 d or 46 Pounds, 14 Shillings and 6 Pence.

Silver was also used as a standard means of exchange. Nevertheless, the price of silver was pegged in relation to gold, and at the time of the Coinage Act, it was set to a ratio of 15 ½ units of silver to one unit of gold.

In time, due to the growth in international commerce, other countries around the world began recognizing and adopting the Gold Standard. They also began issuing paper money which was immediately convertible into physical gold.

The United States adopted the Gold Standard in 1879. Eventually, the U.S. Dollar became the global standard of value and a primary reserve currency when the European nations, along with Britain, were forced to go off the Gold Standard in 1914 because of the outbreak of World War I.

Nevertheless, because of the Great Depression which started in 1929, the United States also had to remove the U.S. Dollar from the Gold Standard in 1933. Then U.S. President Franklin D. Roosevelt even made it illegal for U.S. citizens to hold physical gold.

Paper Money

Because the Gold Standard required money to be issued representing gold on deposit, a constant level of gold had to be maintained by the different governments to back their currencies with the precious metal.

This led to complications involving the balance of trade, since if imports were to high, additional gold had to be purchased to back the currency used to pay for the difference. In part, this was one of the excuses that led to the modern fiat paper money system.

Paper money originally took two forms, receipts for gold held on account and notes which were convertible to gold at a later date. The notes, or banknotes as they were commonly known, were a form of I.O.U. or promissory note which the bank would redeem for an equivalent amount of gold or silver when they were presented.

Gradually, as precious metals were removed as a standard, these notes or "bills" would eventually come to represent solely credit or fiat money. This means the currency is no longer backed by anything except the faith and promise of the issuer to pay, which is the primary basis for money today.