Currency exchange rates reflect what it would cost to buy one currency with another. Retail stores in the United States, for example, do not accept payment for merchandise in Indian rupees. A customer with rupees would need to exchange them for U.S. dollars to complete the transaction. Currency exchange rates allow people to trade one type of currency for a different form of money. Exchange rates vary from one day to the next and may even fluctuate from hour to hour.
Gold From 1500 B.C. to 1934
The earliest gold coins date from 1500 B.C. Gold was first used to back currency in England in 1377. In 1720, Isaac Newton set the price of gold at 84 shillings, 11.5 pence per ounce. This rate remained in effect for more than 200 years. In 1792, the U.S. dollar was valued at 24.75 grains of fine gold. In 1837, an ounce of gold was valued at $20.67.
In 1900, the United States adopted the gold standard and committed to maintain a fixed currency standard for exchange rates. The gold standard was suspended during World War I. In 1933, President Franklin D. Roosevelt made it illegal to privately hold gold bullion, coins or certificates, and he devalued the dollar the following year by increasing the price of gold to $35 an ounce.
The Bretton Woods Agreement
The Bretton Woods Agreement was ratified in 1944 in the New Hampshire town it was named after to establish an international exchange rate. The agreement was a precursor to the International Monetary Fund and the World Bank. The role of the IMF was to monitor exchange rates and lend money to countries with trade deficits, while the World Bank gave developing countries money. At this time, 44 nations agreed to tie their currency exchange rate to the U.S. dollar, which was backed by gold. Many nations bought and sold U.S. currency during this period.
A New Era
President Richard Nixon ended the gold standard in 1971. The U.S. dollar was no longer backed by a real amount of gold held in a vault. The currency exchange rate became a floating rate, determined by market forces of supply and demand rather than being set by the government. Nixon took this action to prevent a run on Fort Knox, which did not contain sufficient gold to cover the U.S. dollars held in foreign countries. The price of gold rose to $38 an ounce at this time. Two years later, gold cost $42.22 an ounce.
In 1974, Americans were allowed to own gold again. Trading in gold on New York’s Commodity Exchange began the following year. The U.S. dollar weakened in the late 1970s, and in 1978, there was no longer an official price for gold. The highest price gold traded for during this time was $870 in 1980.
The Foreign Exchange Market
The foreign exchange market, also called Forex or FX, was created in 1971 when U.S. dollars were no longer backed and exchanged for gold. Exchanging currencies does not require a centralized marketplace. This market is unregulated and is not supervised by any organization. At the time of publication, FX was the largest market in the world, and its major traders are commercial and central banks, multinational corporations and governments. FX trading gained favor with retail investors, as the Internet allowed investors and speculators to trade from anywhere 24 hours a day, except on weekends. The currency exchange rate in the foreign exchange market is set by gross domestic product growth, budget deficits or surpluses, inflation and interest rates. The U.S. dollar, the Japanese yen and the euro dominate the FX market, comprising about 80 percent of all FX trades.
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