The gold standard that was implemented in 1875 first standardized the exchange rate of currencies between countries. In the past, silver and gold was used for international payments. But due to supply and demand, the value of gold either lessens or grows.
Through the gold standard system, governments secured the value of converting currency to gold and the other way around where currency is backed by gold. Major economic countries later on decided on the value of per ounce of gold to the amount of currency. But the gold standard system soon collapsed due to World Wars I and II.
Towards the end of World War II, more than 700 Allies representatives decided on the Bretton Woods system to replace the gold standard system as a monetary system.
Bretton Woods introduced fixed exchange rates method, using the US dollar as a primary currency reserve to replace the gold standard and the emergence of three international agencies that oversee the economic activity – General Agreement on Tariffs and Trade (GATT), International Monetary Fund (IMF) and the International Bank for Reconstruction and Development. This new system appointed the US dollar as the main standard for converting the world’s currency and the only currency backed by gold. The Bretton Woods system eventually failed as the US didn’t have enough gold in their reserves and was unable to continue.
Though the Bretton Woods failed, the international institutions and agencies established live on to aid in today’s economy.
Current Exchange Rates
The world is now using floating currency exchange trading rates as the gold standard has already been removed. Governments now use one of three exchange rates still available today:
This is when countries adopt foreign currency as their national currency instead of using their own for the sake of appearing stable for foreign investment. The downside of this is that the country can no longer make their own monetary policies and no longer print their own currency.
This takes place when a country decides to fasten their exchange rate directly to the currency of another country to gain more stability. The drawback is that the exchange rate for that country’s currency is directly relevant to the situation of the economy of their pegged country.
Managed Floating Rates
This system allows the exchange rate of a country to freely change value while monitored by the market and is related to supply and demand. The central bank or government can intervene should the exchange rates fluctuate in extremes.
These are the different traders in the forex that have different purposes other than those seen in the equity market.
Government and Central Bank
Federal banks and central banks are one of the most influential players in the forex. Their purpose is to balance keeping interest rates low and keeping in check inflation. To meet economic goals, they manipulate their volume of reserves. This is why the government and the central bank go hand in hand when it comes to monetary policy.
Banks and Other Financial Institutions
One of the big participants in the forex, banks act as dealers where they buy/sell currencies at the bid/ask price. Banks usually make money from premium when exchanging currency to the price they bought it for. There are also interbank markets where large banks conduct business with each other where they also determine the prices on their trading platforms.
This strategy is used by most businesses to lock in a fixed exchange rate for the future when they don’t have enough to make spot transactions to fund international transactions. This helps remove risk in the exchange rate for transactions as there are many uncertainties with forex and fluctuations can occur.
These are the market participants that make profit out of the fluctuating exchange rate levels.