Exchange Rates – A History
For centuries exchange rates in the world were backed by gold.
Worth its weight
Gold may not be as valuable as it used to be, but at one stage it was the backbone of currency exchange rates. Phrases like, ‘worth its weight in gold', or ‘good as gold' are rooted in the value gold and currency once had. For hundreds of years, major currencies across the world were supported by gold. Paper money actually represented real gold that would be held in a government vault. The gold bullion is perhaps one of the most enduring images in classic movie bank robbery heists.
Gold and exchange rates
The use of gold in exchange rates became what is known as the ‘gold standard'. From classic antiquity precious metals such as gold was a common medium of exchange throughout Europe. If an object was bought with gold or silver coins, the worth of the coins was determined by the quality and weight of the gold or silver. This meant the exchange rates were relatively fixed, maintained as they were by the value of gold.
Exchange rates fixed by gold
But carrying gold coins around was a heavy business, and Italian bankers issued paper notes in lieu by the 14th century, and four hundred years later paper money was commonplace. When it came to exchange rates however, the value of the paper money was still dictated by gold. Each note was worth a certain weight in gold or silver, and so traders didn't worry about foreign exchange rates fluctuating or impacting on their trade and profit.
Gold standard
Britain adopted the gold standard in 1840 but this collapsed after the First World War thanks to inflation and recession. The gold standard was replaced by the Bretton Woods system - this entailed partially fixed exchange rates. This worked as exchange rates against the dollar were agreed, which was still pegged to gold.
Exchange rates and market forces
By the early 1970s, inflation in America, deficits caused by the Vietnam War and rising oil prices meant the Bretton Woods system came to an end and exchange rates were dictated not by gold but by market forces. However, partially fixed exchange rates dictated Europe in the late 1970s through the Exchange Rate Mechanism or ERM - to encourage economic union.
The Euro and exchange rates
In the early nineties Britain left the ERM as exchange rates meant currencies within the ERM fluctuated by up to 15%, but by the late nineties, the Euro was introduced to continue closer monetary union.
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