Money Market History
The origin
of Money Market (FOREX or Foreign Exchange) trading traces
its history to centuries ago. Different currencies and the
need to exchange them had existed since the Babylonians.
They are credited with the first use of paper notes and
receipts. Speculation hardly ever happened, and certainly
the enormous speculative activity in the market today would
have been frowned upon.
In those days, the value of goods was expressed in terms of
other goods (also called as the Barter System). The obvious
limitations of such a system encouraged establishing more
generally accepted mediums of exchange. It was important
that a common base of value could be established. In some
economies, items such as teeth, feathers even stones served
this purpose, but soon various metals, in particular gold
and silver, established themselves as an accepted means of
payment as well as a reliable storage of value. Trade was
carried among people of Africa, Asia, etc. through this
system.
Coins were initially minted from the preferred metal and in
stable political regimes, the introduction of a paper form
of governmental I.O.U. during the ‘Middle Ages’ also gained
acceptance. This type of I.O.U. was introduced more
successfully through force than through persuasion and is
now the basis of today’s modern currencies.
Before the First World War, most Central banks supported
their currencies with convertibility to gold. However, the
gold exchange standard had its weaknesses of boom-bust
patterns. As an economy strengthened, it would import a
great deal from out of the country until it ran down its
gold reserves required to support its money; as a result,
the money supply would diminish, interest rates escalate and
economic activity slowed to the point of recession.
Ultimately, prices of commodities had hit bottom, appearing
attractive to other nations, who would sprint into buying
fury that injected the economy with gold until it increased
its money supply, drive down interest rates and restore
wealth into the economy. However, for this type of gold
exchange, there was not necessarily a Central bank’s need
for full coverage of the government’s currency reserves.
This did not occur very often; however when a group mindset
fostered this disastrous notion of converting back to gold
in mass, panic resulted in so-called "Run on banks". The
combination of a greater supply of paper money without the
gold to cover led to devastating inflation and resulting
political instability. The Great Depression and the removal
of the gold standard in 1931 created a serious lull in money
market activity. From 1931 until 1973, the money market went
through a series of changes. These changes greatly affected
the global economies at the time and speculation in the
money market markets during these times was little.
The first major transformation, the Bretton Woods Accord,
occurred toward the end of World War II. The United States,
Great Britain and France met at the United Nations' Monetary
and Financial Conference in Bretton Woods, New Hampshire to
design a new economic order. This location in the U.S. was
chosen because, at the time, was the only country unscathed
by war. Most of the European countries were in shambles. Up
until WWII, Great Britain and the British Pound had been the
major currencies by which most currencies were compared.
This
changed when the Nazi campaign against Britain included a
major counterfeiting effort against its currency. In fact,
WWII vaulted the US dollar from an evolved currency after
the stock market crash of 1929 to the benchmark by which
most currencies were compared. The Bretton Woods Accord was
established to create a stable environment by which global
economies could re-establish themselves. The Bretton Woods
Accord established the pegging of currencies and the
International Monetary Fund ("IMF") in hopes of stabilizing
the global economic situation.
Major
Currencies were pegged to the US dollar. These currencies
were allowed to fluctuate by one percent on either side of
the set standard. When a currency's exchange rate would
approach the limit on either side of this standard, the
respective central bank would intervene, thus bringing the
exchange rate back into the accepted range. In addition to
this, the US dollar was pegged to gold at a price of $35 per
ounce. Pegging the dollar to gold and the pegging of the
other currencies to the dollar brought stability to the
world Money market situation.
The Bretton Woods Conference rejected John Maynard Keynes
suggestion for a new world reserve currency in favour of a
system built on the US dollar. Other international
institutions such as the IMF, the World Bank and GATT were
created in the same period as the emerging victors of WW2
searched for a way to avoid the destabilising monetary
crises which led to the war. The Bretton Woods agreement
resulted in a system of fixed exchange rates that partly
reinstated the gold standard, fixing the US dollar at
USD35/oz and fixing the other main currencies to the dollar
- and was intended to be permanent.
The Bretton Woods system came under increasing pressure as
national economies moved in different directions during the
1960’s. A number of realignments held the system alive for a
long time but eventually Bretton Woods collapsed in the
early seventies following President Nixon’s suspension of
the gold convertibility in August 1971. The dollar was not
any longer suited as the sole international currency at a
time when it was under severe pressure from increasing US
budget and trade deficits.
In 1971,
the Bretton Woods Accord was first tested because of
dramatically uncontrollable currency rate fluctuations. This
started a chain reaction, and by 1973, the gold standard was
abandoned by President Richard Nixon. The fixed-rate system
collapsed under heavy market pressures, and currencies
finally were allowed to float freely.
The money
market markets officially switched to a free-floating market
after the double demise of the Smithsonian Agreement and the
European Joint Float. This switch occurred more due to lack
of any other available options, but it is important to
understand that the free floating of currency was not, by
any mean, imposed. This means that countries were free to
peg, semi-peg, or free-float their currencies.
Pegged:
Some smaller economies have attached their currencies to
larger economies with which they hold close economic
liaisons. For instance, many Caribbean nations, such as
Jamaica, have pegged their currencies to the U.S. Dollar.
Semi-pegged:
Semi-pegged currencies have disappeared since 1993. A
perfect example of semi-pegging would be the currencies of
the European Monetary System (EMS). Those currencies only
would be allowed to fluctuate within 2.25 percent or,
exceptionally, within 6 percent intervention bands.
Following the money market crisis of 1993, the new EMS
intervention rates were expanded to 15 percent. Semi-pegging
would have a slowing-down effect on currencies when they
were reaching the extreme values allowed within the range.
Since 1999, the semi-pegged currencies of the EMS were
switched to fully pegged values that form the Euro.
Free-Floating:
When the major currencies, such as the U.S. Dollar, are
free-floating they move independently of other currencies.
The value of the currency is determined by supply and
demand, which has no specific intervention point that has to
be observed, and can be traded by anybody so inclined.
Free-floating currencies are in the heaviest trading demand.
In the
1980s, cross-border capital movements accelerated with the
advent of computers and technology, extending market
continuum through Asian, European and American time zones.
These same technologies made it feasible for private
investors to enter a market that had traditionally been the
sole domain of banks and large institutions.
The last
few decades have seen money market trading develop into the
world’s largest global market. Restrictions on capital flows
have been removed in most countries, leaving the market
forces free to adjust Money market rates according to their
perceived values.
But the idea of fixed exchange rates has by no means died.
The European Economic Community introduced a new system of
fixed exchange rates in 1979, the European Monetary System.
The quest continued in Europe for currency stability with
the 1991 signing of The Maastricht treaty. This was not only
to fix exchange rates but also actually replace many of them
with the Euro in 2002. London was, and remains the principal
offshore market. In the 1980s, it became the key centre in
the Eurodollar market when British banks began lending
dollars as an alternative to pounds in order to maintain
their leading position in global finance.
In Asia, the lack of sustainability of fixed money market
rates has gained new relevance with the events in South East
Asia in the latter part of 1997, where currency after
currency was devalued against the US dollar, leaving other
fixed exchange rates, in particular in South America, also
looking very vulnerable.
While commercial companies have had to face a much more
volatile currency environment in recent years, investors and
financial institutions have discovered a new playground. The
money market initially worked under the central banks and
the governmental institutions but later on it accommodated
the various institutions. At present it also includes the
dot com booms and the World Wide Web. The size of the money
market now dwarfs any other investment market. The money
market is the largest financial market in the world.
Approximately 1.9 trillion dollars are traded daily in the
money market market. It is estimated that more than USD
1,200 Billion are traded every day. It can be said easily
that money market is a lucrative opportunity for the modern
day savvy investor.
Timeline of Money Market History
-
1944 –
Bretton Woods Accord is established to help stabilize
the global economy after World War II.
-
1971 –
Smithsonian Agreement established to allow for greater
fluctuation band for currencies.
-
1972 –
European Joint Float established as the European
community tried to move away from its dependency on the
U.S. dollar.
-
1973 –
Smithsonian Agreement and European Joint Float failed
and signified the official switch to a free-floating
system.
-
1978 –
The European Monetary System was introduced so other
countries could try to gain independence from the U.S.
dollar.
-
1978 –
Free-floating system officially mandated by the IMF.
-
1993 – European Monetary System fails
making way for a world-wide free-floating system.
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