Initially the value of goods was spoken in terms of other goods, i.e. an economy based on exchange between individual market participants. The clear limitations of such a system encouraged establishing more normally accepted means of exchange at a moderately early stage in history, to set a common benchmark of value. In different economies, all from teeth to feathers to pretty stones has served this purpose but soon metals in particular gold and silver, recognized themselves as an accepted means of payment as well as a dependable storage of value. In the beginning, coins were merely imprinted from the preferred metal, but in stable political regimes the introduction of a paper form of governmental IOUs (I owe you) gained acceptance throughout the middle Ages. Such IOUs (Currency notes) often introduced more successfully through force than influence were the basis of modern currencies.
Earlier than the World War-1, most central banks supported their currencies with convertibility to gold. At times, the ballooning supply of paper money without gold cover led to devastating inflation and resulting political insecurity. To protect national interests, foreign exchange controls were increasingly introduced to prevent market forces from punishing monetary irresponsibility. In the latter stages of World War II, the Bretton Woods agreement was reached on the initiative of the USA in July 1944. The Bretton Woods meeting rejected John Maynard Keynes proposal 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 (General Agreement on Tariffs and Trade) were shaped in the same period as the emerging victors of World War-2 searched for a way to avoid the destabilizing monetary crises which lead to the war. The Bretton Woods agreement resulted in a system of fixed exchange rates that partly reinstated the gold standard, and fixing the other major currencies to the dollar - and was intended to be permanent.
See Also: Foreign Exchange Market In India
The Bretton Woods system came under increasing pressure as national economies moved in different directions during the 60’s. A number of realignments kept 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 no longer suitable as the sole international currency at a time when it was under severe pressure from increasing US budget and trade deficits. The following decades have seen foreign exchange trading develop into the largest global market by far limitations on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values.
The EEC (European Economic Community) introduced a new structure of fixed exchange rates in 1979, the European Monetary System. This effort to fix exchange rates met with near extinction in 1992-93, when pent-up economic pressures forced devaluations of a number of weak European currencies. However the quest for currency stability has continued in Europe with the renewed attempt to not only fix currencies but actually replace many of them with the Euro in 2001.
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