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A brief history of currencies

Welcome again everyone to episode 5 of our FX 101 series of podcast episodes! In these episodes, we aim to provide you with bite-sized educational and informative content on a range of topics related to financial markets, FX, economics and more. 

On the last episode of FX 101, we talked about the types of exchange rate regimes, outlining the differences between fixed and floating exchange rates, conventional pegs, stabilised arrangements, currency board arrangements and much more. If you’ve not yet had a chance to listen, be sure to go back and do so, and don’t forget to subscribe to the podcast, and you’ll get notifications when our next episodes become available.

In this week’s episode, we’re going to walk you through a brief history of currencies, stemming all the way back to the barter system, the Gold Standard, through the first bank notes, the invention of mobile banking and, more recently, the launch of digital currencies.

Gold Standard Era

Now the medium of exchange began long before the first currencies were first introduced. Indeed, the barter system was used by Mesopotamian tribes as far back as 6000 BC, where goods (most notably salt and spices) were popular units of exchange for other goods. 

Thankfully this archaic practice was replaced following the production of the first gold coins in around 600 BC in ancient Lydia, which is the current day location of western Turkey. The Lydia stater is widely agreed to be the first coin issued by a government, and had the important characteristics of being portable, a store of intrinsic value and hard to counterfeit.

Bank notes were first said to have been used as early as the seventh century in China, although these were not widely seen in Europe for almost a thousand years.

The first forex market was established in Amsterdam as far back as 500 years ago, which allowed currencies to be freely traded, helped stabilise exchange rates and laid the foundation for modern day financial trading. 

Gold coins were used for many hundreds of years, up until the highly important and significant adoption of the Gold Standard, established in the 19th Century, which became the bedrock of the international monetary system for many decades. 

What was the Gold Standard? Well, this involved countries fixing their respective currencies to a specified amount of gold, or to another currency that was linked to gold. Exchange rates were then determined by the relative value of each currency’s gold fixing. In the UK, the value of one troy ounce of gold was fixed at £4.25, while in the US this was set at $20.67. 20.67 divided by 4.25 gives us the fixed GBP/USD exchange rate of 4.86 dollars to the pound. 

Why was gold used? Well, the important characteristics of gold is that it holds its value, does not degrade over time, and has a fixed supply. 

These currencies, or gold itself, were used as a medium of exchange in international payments. With each currency fixed in value in terms of gold, exchange rates between the currencies that participated in the gold standard were also fixed. So if the exchange rate were to exceed this fixed rate, known as the mint rate, by more than the cost of shipping gold between the two countries, inflows or outflows of gold would be needed until the exchange rate returned to the specific level. 

A form of the gold standard was first used in the United Kingdom in 1821, with the ‘classic’ Gold Standard introduced by the US, Germany and France in the 1870s. And in the years between 1880 and the start of the First World War, almost all of the world’s leading economies took part. 

The Gold Standard had its benefits. Governments were unable to devalue their currencies in order to improve export competitiveness, and with money supply stable, prices were also stable (i.e there was practically no inflation). 

The problem with the system was that interest rates could not be used to respond to booms or recessions, while trade imbalances could not be corrected through changes in the exchange rates. 

The Gold Standard began to fall apart at the beginning of World War One, as governments sought to rapidly increase spending on military expenditure. It was briefly introduced again in the UK in the late-1920s, although this proved short-lived due to the Great Depression. The UK officially ended its use of the gold standard in 1931, followed by the US in 1933, although some countries continued to use it up until the early-1970s. 

Bretton Woods Agreement

Towards the end of the Second World War, the Bretton Woods Agreement was negotiated, albeit it took nearly 15 full years for the system to be fully operational. Under this system, the US dollar was fixed to the value of gold ($35 per ounce to be exact). Participating nations (of which there were 44) then fixed the value of their currency to the dollar, within a range of 1%. 

As part of the agreement, the participating countries were required to monitor their exchange rates, and buy or sell dollars as required in order to maintain their dollar peg. In order to ensure compliance, the International Monetary Fund and the IBRD (now known as the World Bank) were established. These two institutions were crucial in supporting the global economy following the end of the Second World War and, of course, remain important pillars of stability and security in the global economy and financial markets to this day. 

Again, the Bretton Woods system had its clear benefits. The fixed exchange rates minimised currency volatility, allowing certainty in international trade, and rapid growth in the global economy. Indeed, during the Bretton Woods era, developed nations expanded at unprecedented rates. 

By the late-1960s, however, US gold reserves had been eroded, and had become inadequate to cover the amount of dollars in circulation. The dollar had become weak, and major imbalances had formed in the global economy, notably sharp increases in inflation. 

The IMF attempted to salvage the system by introducing Special Drawing Rights, which would take the dollar’s place as the world’s reserve currency. This was, however, too little too late, and by 1970, US foreign liabilities equated to around four times the value of US gold reserves. 

US President Richard Nixon subsequently devalued the dollar relative to gold, which was followed by a run on the US gold reserves. This led to what is known as the ‘Nixon Shock’, whereby the US temporarily suspended its dollar convertibility into gold, placed a 10% tax on imports and encouraged the country’s major trading partners to raise the value of their currencies. 

The Smithsonian Agreement followed in 1971, where the dollar was devalued against gold by 8.5%. This was not enough to save the Bretton Woods system, however, and triggered a run on the US dollar. By 1973, the currency pegs were scrapped, and the currencies that were fixed to the dollar were instead allowed to float freely. 

Since the end of the Bretton Woods Agreement, members of the IMF have been able to choose any form of exchange rate agreement, with the exception of pegging their currency to gold, of course. Again, if you’ve not had a chance to listen to our episode on Exchange Rate Regimes, please go back and have a listen to find out more!

Evolution to Modern Currencies

In more modern times of course, we’ve seen a shift away from cash, towards online banking and digital currencies. The first credit card was invented in 1950, and was known as the Diners Club card, an idea that came about from a business man named Frank McNamara, who had forgotten his wallet while out for dinner in New York. 

Online banking was first launched in January 1987, four years following the advent of the internet, although this did not become mainstream until the mid-1990s. Mobile banking was launched for the first time in the late-90s when the wireless application protocol was introduced, first appearing in Norway in 1999. 

Since then, perhaps the most significant development in the world of currencies has been the formation of virtual currencies. The concept for digital currencies was first bandied around in the early-1980s, although it was 25 years later until the first cryptocurrency (Bitcoin) was introduced, an entirely virtual and privately issued currency designed to not rely on the support of central banks. 

The first block of Bitcoins was mined using blockchain technology by the developer of the cryptocurrency, the mysterious Satoshi Nakamoto, in January 2009. Bitcoin became tradable six months later, although it wasn’t until February 2011 that its value rose above the $1 level. Since then, of course, the market for cryptocurrencies has expanded materially, and as of November 2023, there are around 9,000 active cryptocurrencies in existence. 

Stablecoins were first introduced in 2014. These are a subcategory of cryptocurrencies that are designed to hold their value by being pegged to an asset, whether that be a currency, such as the US dollar, commodities or another cryptocurrency. 

Meanwhile, Central Bank Digital Currencies (CBDCs) have been introduced in recent years. These are similar to cryptocurrencies, in that they are fully digital and paperless, although unlike crypto, they are centralised and issued and backed by governments. It remains very early days for CBDCs, with only 11 countries or territories so far having launched a version of these virtual currencies, although over 100 are engaging in active research. 

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