In 1967, a Chicago bank refused a college professor by the name of Milton Friedman a loan in pound sterling because he had
intended to use the funds to short the British currency. Friedman, he had perceived sterling to be priced too high against
the dollar, wanted to sell the currency, then later buy it back to repay the bank after the currency declined, thus
pocketing a quick profit. The bank's refusal to grant the loan was due to the Bretton Woods Agreement, established twenty
years earlier, which fixed national currencies against the dollar, and set the dollar at a rate of $35 per ounce of gold.
The Bretton Woods Agreement, set up in 1944, aimed at installing international monetary stability by preventing money from
fleeing across nations, and restricting speculation in the world currencies Prior to the Agreement, the gold exchange
standard--prevailing between 1876 and World War I--dominated the international economic system. Under the gold exchange,
currencies gained a new phase of stability as they were backed by the price of gold. It abolished the age-old practice used
by kings and rulers of arbitrarily debasing money and triggering inflation.
But the gold exchange standard didn't lack faults. As an economy strengthened, it would import heavily from abroad until
it ran down its gold reserves required to back its money. As a result, money supply would shrink, interest rates rose and
economic activity slowed to the extent of recession. Ultimately, prices of goods had hit bottom, appearing attractive to
other nations, which would rush into buying sprees that injected the economy with gold until it increased its money supply,
and drive down interest rates and recreate wealth into the economy. Such boom-bust patterns prevailed throughout the gold
standard until the outbreak of World War I interrupted trade flows and the free movement of gold.
After the Wars, the Bretton Woods Agreement was founded, where participating countries agreed to try and maintain the value
of their currency with a narrow margin against the dollar and a corresponding rate of gold as needed. Countries were
prohibited from devaluing their currencies to their trade advantage and were only allowed to do so for devaluations of less
than 10%. Into the 1950s, the ever-expanding volume of international trade led to massive movements of capital generated
by post-war construction. That destabilized foreign exchange rates as set up in Bretton Woods.
The Agreement was finally abandoned in 1971, and the US dollar would no longer be convertible into gold. By 1973, currencies
of major industrialized nations became more freely floating, controlled mainly by the forces of supply and demand which
acted in the foreign exchange market. Prices were floated daily, with volumes, speed and price volatility all increasing
throughout the 1970s, giving rise to new financial instruments, market deregulation and trade liberalization.
In the 1980s, cross-border capital movements accelerated with the advent of computers and technology, extending market
continuum through Asian, European and American time zones. Transactions in foreign exchange rocketed from about $70 billion
a day in the 1980s, to more than $1.5 trillion a day two decades later.
The Euromarket
A major catalyst to the acceleration of foreign exchange trading was the rapid development of the euro-dollar market,
where US dollars are deposited in banks outside the US. Similarly, Euromarkets are those where assets are deposited
outside the currency of origin. The Eurodollar market first came into being in the 1950s when Russia's oil revenue, all in
dollars, was deposited outside the US in fear of being frozen by US regulators. That gave rise to a vast offshore pool of
dollars outside the control of US authorities. The US government imposed laws to restrict dollar lending to foreigners.
Euromarkets were particularly attractive because they had far less regulations and offered higher yields. From the late
1980s onwards, US companies began to borrow offshore, finding Euromarkets a beneficial center for holding excess liquidity,
providing short-term loans and financing imports and exports.
London was, and remains the principal offshore market. In the 1980s, it became the key center in the Eurodollar market
when British banks began lending dollars as an alternative to pounds in order to maintain their leading position in global
finance. London's convenient geographical location (operating during Asian and American markets) is also instrumental in
preserving its dominance in the Euromarket.
