The Bretton Woods Agreement of 1944
The major turning point occurred just before the end of World War II when the Allies gathered in 1944 at Bretton Woods to outline the new post-war global financial structure. A historic handover was decided between the pound sterling and the US dollar as the reference currency in world trade. With this came the decision for the convertibility of the dollar into gold at a fixed price of $35 per ounce (Gold Standard). In general, the exchange rate system was practically based on fixed conversion rates between the dollar and other currencies within a small fluctuation band of 1%. The currency markets' longer history before this turning point is told in the history and origins of Forex.
The Fixed-Rate System Begins to Crack
In the 1950s and 1960s, the fixed exchange rate system began to falter, due to the explosion of volumes in the new globalized era. In 1967, the pound sterling was devalued, and in the early 1970s the US dollar followed suit, devalued first in the December 1971 Smithsonian Agreement and again in February 1973: in both cases, the central banks of the United Kingdom and the United States, respectively, failed to prevent the collapse of their currency on world markets. Fixed rates did not disappear with that system: a majority of the IMF's member countries still run a currency peg of some kind.
Nixon Ends the Gold Standard
In 1971, US President Nixon opened a new era in forex history, launching a more evolved form of Forex compared to what is known today. The era of the Gold Standard ended, and the era of flexible exchange rates began, although initially, the definition of precise oscillation bands was still opted for.
From the European Monetary System to the Euro
In 1973, however, the dollar/mark exchange rate lost 10% of its value, demonstrating how it was becoming increasingly difficult to control exchange rate fluctuations without taking into account what the market thought. In 1978, the European Monetary System (EMS) was born, and with it, the Exchange Rate Mechanism (ERM) for stabilizing currencies against the ECU, practically the ancestor of the euro. In 1992, there was a strong devaluation of the pound sterling and the lira, forcing Great Britain and Italy to leave the EMS.
The devaluation of the two currencies, orchestrated by large hedge funds – now masters of the global financial scene – soon led to the failure of the ERM and the realization of letting exchange rates float without restrictions. Meanwhile, in 1992, the European Monetary Union (EMU) was born, and in 1999, the euro followed. The creation of the European Central Bank (ECB) ensures that the member countries of the EMU adopt a common monetary policy, leaving the individual countries of the Union the possibility to manage their own economies with distinct fiscal policies.
